Rite Aid (NYSE:RAD) is currently quoted in the market at about $3 against our estimated price of $2.07, a staggering difference of about 30%. Much of the appreciation in the stock price was seen after the company reported its fourth quarter earnings in April, when it reported profitability for the first time in the last five years. The stock has gained over 80% in the last three months alone.
Higher generic dispensing rate reduced the company’s cost of inputs, resulting in $107 million of net profits for the fiscal 2013. The company benefited after it refinanced a large portion of its huge debt burden at a lower rate, and it gained from an uptick in the number of customers as a result of Express Scripts-Walgreen dispute. 
Having said that, Rite Aid’s revenue continues to move downhill as the company continues reducing its store count. The total number of stores that Rite Aid operates has shrunk from its all time high of over 5,000 in 2007 to 4,615 on June 1, 2013.  We wouldn’t be surprised if in the near future the store count declines further to 4,550. In this extremely competitive industry structure where a company’s sales is determined by its closeness to its customers, the shrinking store count provides a major reason to be worried about.
Generics Help Boost Bottom Line But Cash Flows Equally Important
Generic drugs help drive overall company margins higher as compared to their branded counterparts, but they also have a severe impact on the top line as they are much cheaper. Rite Aid’s total revenues have declined not only because they are closing their non-profitable stores, but also because of a higher proportion of generics in an average prescription. As reported by Rite Aid recently, its same store sales declined by 1.5% year-on-year.  If we compare it with Walgreen, which recently reported a same store sales growth of 2.8% during the same period, we are disappointed with Rite Aid’s underperformance. 
Cash flows play a major role in expansion when a company already has a huge debt burden. Rite Aid currently owes about $12 billion in debt against annual revenues of $25 billion in 2012.  Such a high level of debt against declining revenues makes it difficult for the company to be able to service its debt, let alone expanding store count. Its dependence on generics can drive the bottom line only so far and growing revenues will pave the way for a brighter future.
Customers Moving Back To Walgreen After The Resolution Of Express Scripts Dispute
Rite Aid’s gained last year when Walgreen was in a dispute with pharmacy benefit management company Express Scripts, causing some of Walgreen’s customers to shift to Rite Aid in order to continue filling prescriptions under their existing program. However these customers are staring to move back to Walgreen since the dispute has been settled.
Convenience and accessibility are major determinants for a consumer while choosing its preferred drug retailer. Rite Aid’s 4,615 stores appear small when compared to its major rivals – CVS Caremark 7,500+ stores and Walgreen 8,500+ stores. Rite Aid’s recent initiatives like the Nail Art Competition  and 3D Kiosks  to promote ongoing rewards and promotions are insignificant ways to boost sales. Also, the company’s continuing efforts towards remodeling stores to the new Wellness+ format is taking a huge toll on its strained cash flows. So far it has remodeled 797 stores to the new format. 
As a result of Rite Aid’s ongoing challenges such as its debt load and declining sales due to stiff competition from its larger competitors, we believe it will be very difficult for the company to maintain the recent momentum in its stock price.
We have a $2.07 price estimate for Rite Aid, around 30% below the current market price.Notes:
- Rite Aid 10K 2013 [↩] [↩]
- Rite Aid Reports Same Store Sales for May, June 2013 [↩] [↩]
- Walgreens May Sales Increase 4.3 Percent, June 5, 2013 [↩]
- Walgreen’s Balance Rewards Program Is Helping Drive Sales, June 2013 [↩]
- Rite Aid Launches 2(nd) Annual Online Nail Extravaganza Contest with Beauty Prizes, Coupons & Tips, May 2013 [↩]
- 3-D kiosk maker expands Rite Aid partnership after 10-store pilot, June 2013 [↩]
- Rite Aid 10K 2013, Page 29, Para 1 [↩]