Has Rite Aid's Growth Story Stalled Out?

What does one bad quarter mean for the company?

Michael Douglass
Michael Douglass
Oct 2, 2015 at 12:17PM
Health Care

Judging by the market's reaction after Rite Aid (NYSE:RAD) reported its FY 2016 Q2 earnings on September 17th, you'd think it has.

RAD Chart

But the market's myopic focus on numbers mean it's ignored the longer-term growth opportunity with this fascinating turnaround story. Rite Aid's still firing on all cylinders, and its future looks increasingly bright.

Let's start with the numbers
Rite Aid's earnings "miss" -- it reported $0.02 in diluted EPS as opposed to the Street's anticipated $0.04, either way a big drop from last year's $0.13 -- received a great deal of attention. But the real story is more complex than the simple numbers game. Rite Aid's financing activities and expenses related to the purchase of the pharmacy benefit manager (PBM) EnvisionRx shaved $0.05 off of EPS this past quarter. That financing activity included early payment of Rite Aid's 8% first lien notes, which should save the company $30 million a year in interest expense (or about $0.03 per share based on current share count). That was a good move -- refinance lower wherever possible.

Oh, and don't forget that Rite Aid beat expectations on revenue and grew sales 17.5% year over year -- although the vast majority of that growth came from the EnvisionRx deal, as the retail pharmacy segment (Rite Aid's traditional, bread-and-butter business) only grew sales 1.9% year over year.

And, let's face it, there were legitimately concerning numbers that can't just be explained away, chief among them management's reduced guidance for same-store sales growth. While Rite Aid had previously guided for 2.5% to 4.5% growth in same-store sales, it has now updated that guidance to 1.5% to 2.5% growth in comps, which management has attributed to weaker sales and a tough comp with last year's Medicaid expansion-fueled growth.

But Rite Aid's growth isn't predicated on a single quarter's hit or miss. And the company is executing well on its big growth drivers, which should help fuel impressive growth in the years to come.

Plenty of Plenti
Forgive the pun -- sometimes I can't help myself. Plenti, the first coalition loyalty program in the U.S., links together Rite Aid, ExxonMacy's, and other retailers with one card that can earn rewards points at all participants' locations. For Rite Aid, it's a chance to bring in new customers who aren't particularly conscious of there being any difference between Rite Aid and its major competitors, CVS and Walgreen's. Rite Aid has enrolled 17.6 million customers in Plenti, and more than 50% of Rite Aid's store transactions now occur with a wellness+ with Plenti card. When you add in the customers that Rite Aid's partners elsewhere are enrolling in Plenti, it's a big opportunity to get a lot of new customers.

Rite Aid's challenge, then, will be to educate those customers on the wellness+ tier structure and create a stickier relationship that keeps them coming back longer term. This is not the kind of thing that happens overnight -- as President and CEO Kenneth Martindale noted on the call (this quote courtesy of S&P Capital IQ), "We're still seeing some maturation with Plenti as customers get used to it, and we're looking forward to Plenti paying some pretty good dividends as customers do get more accustomed to how it works."

Given time, this is a big opportunity to build a strong additional base of repeat customers.

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Immediate returns
If there's a slam-dunk growth opportunity for Rite Aid, the wellness remodels are it. Reconfiguring stores to the wellness format pays serious, immediate dividends for Rite Aid, with stores remodeled within the last two years generating a 3.5 percentage point bump in front-end same-store sales compared to non-wellness stores, and a 1.3 percentage point bump in script growth. Last quarter, Rite Aid finished 119 wellness remodels and has now expanded the format to over 1,800 stores, or 41% of the overall store count.

It's an easy win, and while I'd personally like to see Rite Aid do a remodelling bonanza and get them all done already, I understand management spreading out the spending over a number of years, which gives it more flexibility for acquisitions.

Speaking of which...

The market's sweet spot
Rite Aid's purchase of EnvisionRx earlier this year gave the company a large, growing market to play in -- drug spending in the U.S. is soaring, and PBMs make their money by negotiating lower drug prices with pharmaceutical companies. There is a tremendous need for PBM services, particularly in the specialty drug market, which should help fuel growth in this space for years.

EnvisionRx has done exceptionally well this year, as its calendar 2015 selling season has netted it 700,000 net new members so far -- and that's without including potential Q4 2015 wins. Specialty drug monthly prescription volume at Envision has increased by 37% in the last six months. While it's early days yet for the acquisition, the selling season thus far gives me lots of optimism for Rite Aid's growth with Envision long term.

Rite Aid isn't stalling
The numbers this past quarter were tough -- there's no denying that -- but to my mind, they represent a minor bump in the road. Rite Aid's longer-term growth story remains intact, and management's push into Plenti, wellness remodels, and the PBM market should give the company a nice ramp for years to come.