Nice growth in revenue. Better than expected earnings. And, oh yes, the rest of the year won't be nearly as good as we thought it would.
That message from Rite Aid Corporation (RAD +0.00%) on Thursday morning sent shares into a downward spiral. By the end of day, the pharmacy chain's stock had dropped more than 18%. There is more to the story, though. Here are five things from Rite Aid's second-quarter earnings conference call that management wants you to know.
1. Reimbursement rates will remain problematic
Rite Aid is lowering its earnings outlook for the rest of the fiscal year partially because of reimbursement rate pressure. Management now predicts that the pressure will worsen in the second half of fiscal 2015.
Perhaps the more significant issue relates to the challenge that Rite Aid's team faces in accurately projecting the impact of this reimbursement pressure. CEO John Standley readily admitted that "it is not a perfect science" because of the complexity. Although the company has plenty of fixed-rate contracts, there are different rates within those contracts. Customers can also move to different plans with the same payer and migrate among different payers.
2. Generic gains will remain elusive for now
Those troublesome reimbursement rates wouldn't be as big of an issue if Rite Aid could count on better margins from generic drugs. Unfortunately, that's not currently the case.
One problem is that Rite Aid counted on the availability of a generic version of Nexium. However, Ranbaxy Laboratories still hasn't secured FDA approval of its generic drug. Another challenge is that some generic versions of drugs that recently lost exclusivity have higher price tags than Rite Aid anticipated. Because of these two issues, the profits from generics that the drugstore chain would typically count on won't be as great as hoped for -- at least not for now.
3. McKesson momentum will build
Rite Aid's distribution deal with McKesson already helped improve profits for the second quarter. That momentum will build, according to Standley.
The arrangement with McKesson should help Rite Aid combat reimbursement rate pressure and obtain lower costs on generic drugs. That's the good news. The bad news is that the transition is taking longer than desired. Standley estimated that one-half to two-thirds of the reduced earnings guidance can be attributed to the slower McKesson rollout combined with the delay in approval for generic Nexium.
4. Healthcare hurdles will be jumped
Competitors like CVS Health and Walgreen are aggressively moving to position their stores as healthcare centers. Rite Aid's management affirmed their commitment to do the same.
Ken Martindale, Rite Aid's president and COO, stated that 1,433 stores have been remodeled to support the company's Wellness model. These Wellness stores will be able to accommodate RediClinic medical clinics and initiatives like the Rite Aid Health Alliance, which brings physicians, in-store care coaches, and pharmacists together to provide chronic condition care for patients. That's promising since the Wellness stores outperform other stores in front-end sales and script count.
5. Obamacare opportunities will help
At least one aspect of health reform is making a difference for Rite Aid so far. Standley credits Medicaid expansion as an important driver of higher prescription fills.
What about the impact of Obamacare outside of the Medicaid expansion? Standley admits that it is difficult to quantify right now. However, he believes Rite Aid will experience script growth as a result of more patients gaining access to healthcare.
Half empty or half full?
If we were to summarize all of the above points into one thing Rite Aid's management would like investors to know, it would probable be this: The glass is half full. That might be hard to swallow after the shellacking the stock took on Thursday, but it's something to think about.
Reimbursement rate pressures won't go away, but the introduction of lower-cost generic drugs (including a generic Nexium) and benefits from the McKesson distribution deal will help over time. Converting more stores to the Wellness model should improve sales and profits. Health reform should continue to boost the numbers of potential Rite Aid customers.
That's not to say the next quarter or two won't be challenging. They probably will be. However, some of the best investing opportunities present themselves when temporary issues cause a stock to go down for a company that has long-term trends working in its favor. That's one thing astute investors should definitely know.
