Rite Aid (NYSE:RAD), the third largest drug retailer in the U.S., reported last week that total drugstore sales in the month of February were down 3.7% to $2.5 billion. Prescription sales account for almost 67% of Rite Aid’s sales and we believe the decline due to the return of Express Scripts prescriptions to Walgreen (NYSE:WAG) and the growing penetration of generics sales. Both of these trends negatively impact Rite Aid’s sales from prescription drugs.
The company has debt of about $6 billion, and this has negatively impacted its marketing budgets and expansion plans. While the recent completion of a series of debt refinancing moves will free necessary capital to invest into these activities, we believe that the company will continue to lose Express Scripts prescriptions to Walgreen.
The loss of prescriptions and the growing generic penetration support our $1.50 Trefis price estimate of Rite Aid, which is about 15% below the market price. The company competes with its bigger peers Walgreen (NYSE:WAG), CVS Caremark (NYSE:CVS) and Wal-Mart (NYSE:WMT) in the retail pharmacy business.
Express Scripts Prescriptions Moving Back To Walgreen
In July last year, Express Scripts and Walgreen renewed their deal which enabled Express Scripts users to fill their prescriptions at Walgreen again, starting mid-September. While the inertia will help Rite Aid retain some of the customers it gained as a result of this dispute, many of the customers probably preferred Walgreen for a reason. Transferring prescriptions is not very difficult, and is not enough of a barrier to retain them. The impact of the new arrangement between Express Scripts and Walgreen was telling in February, when the prescriptions filled count rose by only 0.3% year-over-year. In contrast, the growth was in the 4-5% range in December – January. This deceleration in growth is in line with a growth in prescription filled at Walgreen during the same period.
Smaller Footprint Will Limit Rite Aid’s Share In Expanding Coverage Under Obamacare
Rite Aid operates about 4,600 stores in comparison to about 7,500 stores operated by CVS and 8,500 operated by Walgreen. This severely limits Rite Aid’s accessibility. We believe that Rite Aid wont be an obvious first choice for the almost 30 million people who are expected to join the ranks of insured patients on January 1, 2014, as per the provisions of Patient Protection and Affordable Care Act 2011, or Obamacare. This expansion of insurance coverage will result in growth in the number of prescriptions filled, but Rite Aid starts with a disadvantage when compared to competitors.
Growth In Generics Penetration To Keep Revenue Per Prescription Under Check
Rite Aid’s struggle in growing prescription revenues will be compounded by a growth in generic penetration. Generic versions of a drug cost a fraction of the branded version’s price. In 2012, an estimated $35 billion of prescription drug sales were exposed to generic competition. This was the primary cause behind Revenue Per Retail Prescription filled at Rite Aid declining from $60 in 2011 to $56 in 2012. A similar trend was observed at Walgreen and CVS.
An estimated $260 billion of prescription drugs sales are scheduled to go off patent between now and 2018.  Blockbusters with a combined $170 billion in annual sales will lose patent between 2012 and 2015.  The rate at which branded drugs get replaced by generic alternatives is expected to continue at near 2012 levels in the near term, and will keep the revenues per prescriptions under check.
Focus On Increasing Efficiency
The number of stores operated by Rite Aid decreased from 4,667 in February 2012 to 4,623 in February 2013. The decrease was a result of its efforts to focus energies on more profitable operations. Accordingly, the company has been closing or relocating inefficient or loss making stores and converting an increasing number of them to its Wellness format. These efforts are combined with a push to its loyalty program that provides benefits to enrolled members based on the accumulation of points for certain front end and prescription purchases. Members of the program account for about 75% of front end sales and 70% of prescriptions filled. Also, the program members tend to spend more and are more easily retained. We believe that despite its struggles, the focus on increasing efficiency combined with the debt refinancing would help Rite Aid remain profitable in the near term, and in the long term deliver results which would drive future growth.
We have a $1.50 Trefis price estimate of Rite Aid, which is about 5% below the market price.Notes: