Please ensure Javascript is enabled for purposes of website accessibility

Rite Aid's Earnings: A Bandage, Not a Cure

By Michael Lewis - Apr 18, 2013 at 9:31PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The drug store's annual earnings turned positive for the first time since 2008, but before you celebrate, you need to look closer.

Drug store chain Rite Aid (RAD 5.21%) sailed to new highs this week as the company reported in its earnings release a return to annual profitability. The $2 billion company is trading up over 40% in the last year, and 60% since the beginning of 2013. The thing is, earnings did not show much to celebrate in the operating business, and its black bottom line was more the result of cost-cutting efforts and margin enhancement. At more than 20 times forward earnings, the market clearly is expecting some degree of sales growth down the line. Is this an accurate assumption, or should investors exercise caution?

Headline numbers
The Street was expecting a loss for the fourth quarter of 2012, even though the company had achieved profitability in the prior quarter -- against analyst estimates. Instead, Rite Aid posted earnings per share of $0.13. This helped lead the company into its first profitable year since 2008, to the delight analysts. In the prior year's quarter, the company posted a loss of $0.18 per share.

While the headline numbers look appealing, investors need to read between the lines. Fourth-quarter revenues were actually down by $600 million, though partially due to the prior year's fifty-third week. More importantly, same-store sales sank 2% year over year, due, in part, by more generic drugs at the pharmacy. Management was eager to point out that generic drugs tend to drag down sales, but prove helpful to gross profit.

For the year, the company earned $0.12 per share, with an adjusted EBITDA of $1.13 billion. Same-store sales dropped a negligible 0.3%. The company closed 44 underperforming stores, and remodeled over 500. It did not open any new stores.

What investors need to focus on
I'm a sucker for turnaround stories, but this one has yet to ring a positive tone for me. The return to profitability is commendable, and clearly, management has taken action to get the company on a growth track -- like its peers Walgreens and CVS. But remember that these seemingly positive figures are not indicative of sales growth or any other organic factor. In the coming quarters, investors need to keep an eye on two crucial metrics: same-store sales and sales per square foot. With the massive remodeling (and closure of unsalvageable stores), we need to see these numbers swing up in a material way. Store remodelings are great, but only if they result in more customers and more sales. At this point, we just don't know if that's the case.

For 2014, EBITDA is projected to come in at just over $1 billion, with net income between $0.04 and $0.20 per share. This guidance is likely hinged upon the efficacy of continued cost-saving measures, and the upward performance of newly remodeled stores.

Investors intrigued by Rite Aid's recent rise may want to wait until more data is available regarding the remodeled stores. The company's cost cutting and reorganization has been effective, but at some point, sales growth must take the front seat.

More from The Motley Fool 

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Rite Aid Corporation Stock Quote
Rite Aid Corporation
$6.06 (5.21%) $0.30

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/17/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.