The first two fiscal quarters of 2014 were downright dismal for Rite Aid Corporation (NYSE:RAD) investors. Rite Aid's failure to deliver cost savings from its new drug purchasing and distribution deal with McKesson (NYSE:MCK) and its struggle to offset margin pressure tied to higher generic drug prices and a larger number of low-profit Medicaid customers, led to shares being nearly cut in half from their highs this past spring. But, oh what a difference one quarter can make. Rite Aid's fiscal third quarter results offer hope to long-term investors that the company is overcoming obstacles and better able to accelerate profit in the coming year.
By the numbers
Despite operating 23 fewer stores in the quarter than it did one year ago, Rite Aid's sales climbed 5.4% year-over-year to $6.69 billion in the fiscal third quarter. That sales growth stems from improving same-store sales, both in the front of the store and in the pharmacy.
Thanks to Wellness remodels and more customers reaching higher reward discount levels on purchases, front end same store sales grew 1.6% during the quarter. That marked a solid improvement from the flat front end performance notched in the fiscal first quarter and the 1.1% growth in front-end sales during the fiscal second quarter.
Rising enrollment in private insurance plans, thanks to both job growth and health care exchanges, as well as public insurance plans as a result of Medicaid expansion, helped pharmacy year-over-year sales jump too. In the quarter, pharmacy same store sales increased by 7.2%. That surge in pharmacy sales was driven by a 4.5% lift in prescription volume, which more than offset a 2.28% headwind tied to the introduction of new, lower-priced generic drugs this year.
Rite Aid's top line growth led to a very strong bottom line performance in the quarter too.
Rite Aid, which had previously cut its earnings guidance in each of the past two quarters, significantly bumped up its full year earnings outlook after delivering net income of $104.8 million, or EPS of $0.10. Those earnings handily outpaced the $71.5 million in net income, or $0.04 in EPS, recorded a year ago.
As a result, Rite Aid, which had issued guidance for between $0.22 and $0.33 for the full year 2015 following its fiscal second quarter, increased its full year guidance to between $0.31 and $0.37. Rite Aid's new guidance for $0.31 on the low end matches the low end forecasted by the company exiting fiscal 2014, when it had projected full year EPS of between $0.31 and $0.42.
The improving guidance suggests that Rite Aid is finally beginning to see some of the benefit of shifting its generic drug purchasing and direct-to-store drug distribution to drug wholesaler McKesson. Rite Aid has indicated that margin advantages tied to McKesson's bigger buying power, which could be used to negotiate better prices, and savings tied to removing itself from inventory management, by reducing operating costs, will give it more financial flexibility to focus on plans for future growth.
Those plans include the ongoing remodeling of Rite Aid stores to the Wellness format. Since Wellness format stores have been outperforming non-Wellness remodeled stores, the company continues to shift to the new format. Over the past three quarters, the company has remodeled 412 locations that should offer same-store tailwinds in the fiscal fourth quarter. The company will likely continue to invest in those remodels given that only 1529 of the company's 4595 stores have been remodeled to the Wellness format so far.
Rite Aid's guidance increase is welcome news for investors who were worrying about another decrease following cuts in each of the past two quarters. It suggests that Rite Aid is overcoming headwinds and is better prepared to benefit from demographic tailwinds, including graying baby boomers, and regulatory tailwinds, including health insurance membership growth. If this is the case, then Rite Aid investors' patience over the past two quarters may be rewarded over the coming year.