The recovery of Rite Aid's (RAD +0.00%) stock is due, in part, by the steps taken by management to optimize the company's operations. Rite Aid's market is also expected to grow in the coming years as Obamacare may increase the demand for health care treatment.
In order to better understand Rite Aid's recovery, let's examine the changes in the company's average store in terms of profit margins and revenue. Have Rite Aid's sales per store risen in the past quarter? How is the company doing compared to other leading health care-retail giants such as Walgreen (WAG +0.00%) and CVS Caremark (CVS +2.57%)? Let's explore these issues.
Rite Aid's store changes
Rite Aid has been trying to improve its business by closing unprofitable stores and remodeling old ones. In the past quarter, Rite Aid closed a net of 48 stores. But the company hasn't just closed stores; it has also remolded and relocated stores in order to improve its profitability and operations.
In the past quarter, the company remolded 109 stores and relocated five stores. The company is likely to continue implementing these changes. Thus, these initiatives are likely to temporarily increase Rite Aid's operational cost, but over time these steps may improve the company's profitability.
On the other hand, Rite Aid's competitors continue to expand their reach by increasing their number of stores: During the second quarter, CVS Caremark added a net of 160 stores, which represents around a 2.1% gain; Walgreen added 207 stores – nearly a 2.6% increase compared to the second quarter in 2012. Let's examine the recent changes in Rite Aid's sales and profit margins per store.
Sales and profitability per store
To get a better grasp on Rite Aid's progress, I have divided the company's revenue and operating earnings by the number of stores in the past quarter. The table below presents these findings.
Source: Rite Aid's quarterly earnings report
As seen, Rite Aid's revenue increased by a slight 0.6% in the past quarter. Moreover, the drop in the number of stores has resulted in a higher growth rate in revenue per store. In total, the company's revenue per store has increased by 1.7% (year-over-year).
Conversely, the company's earnings before interest and taxes and EBIT per store have fallen by 26.1% and 25.3%, respectively. Therefore, even though the company's average store sold more, its EBIT per store sharply fell. Let's turn to Rite Aid's leading competitors and examine how they have done.
How is the competition doing?
Walgreen's has done much better than Rite Aid in terms of growth in revenue: Walgreen's net sales increased by 3.2% in the past quarter. But after examining the company's growth in stores, Walgreen hasn't increased its sales per store by a high margin as seen in the table below.
Source: Walgreen's quarterly earnings report
Source: CVS Caremark's quarterly earnings report
Based on the above, let's turn to examine how these developments may have affected Rite Aid's valuation compared to other drugstores chains.
Valuation
Rite Aid's P/E doesn't seem too high at 15.5 compared to the pharmacy-services market average of 13.9 or compared to other drugstore chains such as Walgreen, which has a P/E of 24.5. But after considering these companies' debt, cash and earning before interest and taxes, Rite Aid's enterprise-value-to-EBIT ratio isn't that low.
The table below summarizes the EV-to-EBIT ratio of Rite Aid, CVS and Walgreen.
Source: Google Finance Damodaran's website, and wikinvest
Based on the table above, Rite Aid's ratio is at 14. In comparison, CVS's ratio is only 10.7, and Walgreen's ratio is 16. This puts Rite Aid in the middle of the pack in terms of valuation.
One reason for Rite Aid's high valuation compared to the pharmacy-services market is its potential rise in revenue on account of the management's steps to improve the company's operations as presented above. This suggests that investors still believe Rite Aid will be able to grow faster over the long term compared to the other companies in the pharmacy-services market.
Bottom line
Rite Aid is heading in the right direction by closing non-profitable stores and improving other stores. Nonetheless, the sharp rise in Rite Aid's valuation might eventually reach a halt if the company doesn't start to grow its business. Finally, the company's thin profit margin and low sales per store are likely to make it harder for Rite Aid to augment its business over time.
