Rite Aid (NYSE:RAD), the third largest drug retailer in the U.S., reported this Thursday that revenues for the third quarter were down 1.2% to $6.2 billion as a result of a decrease in pharmacy same store sales and store closings. However, the quarter was its first profitable quarter in almost five years with net earnings of ~$62 million against a net loss of $52 million during the same period last year. The return to profitability was helped by strong growth in front-end same-store sales, prescription count and pharmacy gross margins. Generic drugs have higher gross margins than branded drugs and have been instrumental in pharmacy gross margin improvement. The same-store prescription count has now grown for 8 consecutive quarters helping the company turn around from a loss making spree.
The year-t0-date net loss has now narrowed down to $5 million for the fiscal year and a profitable fourth quarter could see the company report a profitable FY 2013.  Buoyed by the success of its turnaround efforts, the company also increased its fiscal 2013 earnings forecast. We expect the return to profitability to spur spending in sales and marketing which should help the company grow sales going forward.
Revenues Decline While Margins Improve
Rite Aid reported a 2.7% decrease in pharmacy same-store sales and 1.5% decrease in total same-store sales. The primary reason behind the decline was a growth in generic penetration which crossed the 80% threshold during the quarter as patients sought low-cost options for their medication therapy. The decline was mitigated by a growth in same-store prescription count by 3.6% during the quarter. Generics also resulted in gross margins improving ~3 percentage points to 29%. 
Growing Prescription Count To Mitigate Generics Negative Impact
A major factor behind the growth in prescription count were the patients who came to Rite Aid as result of the Express Scripts/ Walgreen dispute. The company seems to have retained a substantial number of these patients after the dispute ended September 15. It estimates to have benefited in the range of $18 million to $22 million from Express Scripts scripts during the quarter and expects its loyalty programs to help it retain those customers going forward.
The company is also promoting the convenience of its stores by encouraging users to get flu shots at their neighboring Rite Aid. Its pharmacists have administered 1.8 million flu shots so far this year and look set to achieve the target of 2 million shots. We expect the growth in the number of Wellness stores, the promotion of Wellness+ customer loyalty program and increased traffic resulting from flu shot administrations to help it marginally grow its market share in prescriptions filled in the U.S.
Wellness Store Introductions To Build Loyalty
The company had set a goal of having nearly 800 wellness stores by the end of fiscal year 2013. It converted an additional 117 stores this quarter bringing up the total number of converted stores to 687. These stores are manned by Wellness Ambassadors who are trained to provide customers a one-of-a-kind-shopping experience. The stores have had a positive impact on the sales so far and we expect the company to continue these conversions to build on its wellness+ customer loyalty program in order to develop loyalty among customers. At the end of the quarter, the wellness+ program had approximately 25 million active members, defined as those who have used their card at least twice in the past 26 weeks. The number represents a 5% increase over the same period the previous year and signals the growing loyalty towards the Rite Aid brand. Increased loyalty would further support a growth in same store prescription count and front end sales over the coming quarters.
Positive Reception of Rite Aid’s Private Brand
The company is promoting its new Rite Aid brand architecture to lure customers into purchasing Rite Aid branded products. The company converted 2,900 items to the new architecture last year and followed it up with conversion of seasonal private brand items this year. This has helped it grow private brand penetration to 18%, an increase of 1.3% over the prior year period. The private brand products carry higher margins and should help the company succeed in its crusade for margin improvement.
We are in the process of revising our $1.50 Trefis price estimate of Rite Aid.Notes:
- Rite Aid Management Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, December 2012 [↩]
- Third Quarter FY 2013 Presentation, Rite Aid, December 2012 [↩]