Investors nervous that Rite Aid Corporation's (NYSE:RAD) cuts to earnings guidance in the fiscal first and second quarters would lead to additional reductions in the recently reported fiscal third quarter can breathe a bit easier. Rite Aid reported respectable sales and earnings performance that give Rite Aid's financials a much-needed shot in the arm.
In the third quarter, Rite Aid reported that total sales climbed by 5.4% year over year to $6.69 billion, an impressive showing given that Rite Aid operated 23 fewer stores in the quarter than it did a year ago.
Rite Aid also reported that same-store pharmacy sales increased by 7.2%, and front-end sales increased by 1.6% versus a year ago during the quarter, leading to earnings per share of $0.10, which was handily better than the $0.04 reported in the fiscal third quarter the year before.
Digging into financials
Rite Aid's performance helps restore confidence that the company is getting its arms around margin headwinds that have recently weighed down results, which I've discussed previously, and it also pumps up Rite Aid's financial ratios.
One of the metrics I like to use to judge a company's balance sheet is the current ratio. The current ratio provides quick and simple insight into whether a company can make good on its short-term financial obligations. The higher the ratio, the better, and in the case of Rite Aid, the company's current ratio of 1.77 exiting last quarter improved slightly from 1.74 coming out of the previous quarter.
Rite Aid's ability to pay its bills if creditors come knocking is important, but only if Rite Aid is making money. That's why I also like to consider a company's operating margin, which shows you the percentage of sales that a company spends generating those sales.
Although pesky margin headwinds tied to a rising number of customers participating in lower-paying government programs like Medicaid have resulted in Rite Aid's operating margin remaining below its 2013 levels, trailing-12-month profitability did tick up during the recent quarter. That uptick to 2.91% may suggest that the company is on the right path to overcoming its margin struggles.
In addition to an improving current ratio and operating margin, Rite Aid is also producing more free cash flow. That's important because free cash flow is necessary if Rite Aid is going to transform itself from a company that is restructuring into a growth business again. On the company's most recent quarterly earnings conference call, Rite Aid told investors to expect free cash flow of between $325 million and $375 million for the full fiscal year. If Rite Aid makes good on that forecast, it would mark a solid improvement over the $281 million in free cash flow the company generated last fiscal year.
The company's improving financial footing may suggest that Rite Aid is better prepared to invest in growth initiatives such as its in-store RediClinic healthcare clinics, but is Rite Aid a cheap stock for investors to buy?
Using the fiscal year ending March 2016, the company's forward price to earnings ratio is 17.94, which is pretty much where it's been in the past, and isn't as low as it was last fall, after shares had slipped following the company's previous earnings warnings. However, Rite Aid isn't overly pricey relative to its peers. CVS Health, for one example, has a forward P/E ratio of 18.5.
Investors probably shouldn't be too nervous about valuation in terms of price to sales, either. Using revenue numbers for the trailing 12 months, Rite Aid has a price to sales, or P/S ratio, of just 0.29. Again, this is better than CVS Health, which boasts a P/S ratio of 0.80.
Investors may also take some comfort in knowing that Rite Aid's price to earnings growth, or PEG, ratio appears to be attractive, too. That ratio, which incorporates forecasted growth over the coming five years, stands at just 0.56, which is well south of CVS Health's 1.47 reading.
Tying it together
Rite Aid's recovery appears to be continuing, but that doesn't mean Rite Aid is in the clear. Despite restructuring its debt and closing stores, the company's profitability still trails peers, including CVS Health. That could indicate that any number of things -- including competitive pressures from Walgreen Boots Alliance and CVS Health -- could push Rite Aid's results back into the red, suggesting Rite Aid remains a speculative stock best suited for risk-tolerant investors. However, for investors willing to take on the risk of Rite Aid stumbling, the company's financials and valuation may suggest Rite Aid is a stock worth owning.
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. 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.