Rite Aid Corporation (NYSE:RAD) went from stock market darling to dud this past year, but solid fiscal third quarter results suggest that shares could return to their winning ways.
Despite operating 23 fewer stores during the quarter than it did a year ago, Rite Aid posted solid revenue and profit growth and boosted its full year forecast, which may indicate that the company's profit headwinds, including a slow-to-pan-out deal with McKesson and thinning pharmacy margin, are abating. If so, the company may be able to concentrate more on its plans for growth. Here are three quotes from Rite Aid's third quarter conference call that imply that's the case.
1. "With all of our stores receiving direct-to-store delivery five days a week, we expected to generate working capital benefits and improved in-stock positions to better serve our customers. These benefits were in line with our expectations during the third quarter. In addition, our new purchasing agreement yielded savings during the quarter." -- John Standley, CEO
In a bid to free up capital for future growth, Rite Aid expanded its relationship with drug wholesaler McKesson earlier this year to include generic drug purchasing and direct-to-store drug distribution. Rite Aid indicated that McKesson's buying power would help it get better prices and that eliminating costs tied to managing drug inventory and distribution would prove to be profit friendly, but those projections have been slow to pan out. In fact, Rite Aid's inability to capture the benefit from its agreement with McKesson is one of the reasons behind the company lowering its EPS guidance in both the fiscal first and second quarters.
Coming out of the second quarter, Rite Aid had indicated that the benefits would start to show-up in the second half of its fiscal year, and, based on Standley's comment, that appears to be happening. If Rite Aid continues to reap advantages from the deal, then it may be a bit easier for it to deliver earnings growth next year, especially given weaker year-over-year comparisons tied to a disappointing fiscal first half.
2. "We continue to face significant reimbursement rate pressure. However, we were able to mitigate this pressure during the quarter. We expected this reimbursement rate pressure will continue to pose a challenge heading forward and are working hard as a team to meet this challenge head on." -- Standley.
The company appears to be a bit further along in overcoming hurdles tied to the McKesson deal than it is to overcoming its prescription drug profit squeeze, but the fact that the company was able to mitigate the pressure this past quarter is encouraging.
Profits are being squeezed on one end by rising demand from government insurance plan members, which have less-friendly reimbursement rates than private insurers, and on the other end from stubbornly higher generic drug prices. Medicaid expansion and rising Medicare enrollment mean that more of Rite Aid's sales will continue to come from government programs in the years ahead, so it's likely that a solution to the problem will have to stem from cost cuts or from successfully cross-selling these patients other higher-margin services. Personally, since Rite Aid's competitors CVS Health and Walgreen & Co are arguably navigating the same issue better, I think Rite Aid should be able to figure it out too.
3. "Meanwhile, our initiative to add RediClinics to Rite Aid stores is gaining tremendous momentum. We have opened our first RediClinics in Philadelphia and Baltimore and will be announcing additional openings in the near future." -- Standley.
One of the biggest concerns I've had about Rite Aid is whether or not it will be able to transition itself from a restructuring story back into a growth story. A key component of Rite Aid's growth strategy rests on its ability to expand more deeply into healthcare services, something that CVS Health's MinuteClinic has done remarkably well.
Rite Aid acquired RediClinic, a 30-location healthcare clinic chain, earlier this year and had previously indicated a commitment to opening a flurry of them within its existing Rite Aid stores -- a commitment the company is now delivering on. During the quarter, Rite Aid opened 18 RediClinics across Philadelphia and Baltimore, and it plans to have a total of 35 RediClinics open by early spring, including some in Seattle. During the company's third quarter conference call, the company also reiterated plans to open additional RediClinics in Texas, a move that is critical given that Rite Aid currently doesn't operate any retail pharmacy stores in this state that is a big market for retirees that require more healthcare products and services.
Thanks to same store sales growth of 5.3%, Rite Aid's fiscal third quarter revenue grew 5.3% to $6.7 billion, which led to the company reporting net income per share of $0.10. That was far better than last year, when the company earned just $0.04 per share. It could also be a sign of things to come, particularly if Rite Aid gets better at managing its margin risks.
Todd Campbell is long Rite Aid. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool recommends CVS Health and McKesson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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