Rite Aid (NYSE: RAD), the third largest drugstore chain in the U.S. in terms of revenue and number of stores, ended September and October 2013 with a 1.9% and 2.1% year-over-year increase in same-store sales, respectively. Fiscal 2013 marked Rite Aid’s first profitable year in five years and the positive trend has continued so far this year. (Fiscal years end with February.) Backed by its store re-modeling initiative, efficient cost management and customer loyalty programs, Rite Aid reports that it has seen a better-than-expected performance in the first two quarters of fiscal 2014. Driven by higher pharmacy sales, the company ended Q2 2014 on August 31 with $6.3 billion in revenues. (Read: Strong Results Show Rite Aid’s Remodeling Initiative Is Paying Off)
While Rite Aid believes that its growth in the second half will slow somewhat, it remains confident about its long-term prospects as its turnaround strategy continues to reap benefits. With a valuation of $2.95, which is at a significant discount to the current market price, we maintain a cautious outlook for Rite Aid.
Quick Snapshot Of October Sales
While Rite Aid marked a 0.6% year-over-year decline in front-end (i.e., non-pharmacy) same store sales, it witnessed a 3.4% rise in pharmacy sales same store sales during October 2013. At $1.96 billion, total drugstore sales grew by 2.2% year over year, of which 69.1% was accounted for by prescription sales. The prescription count at comparable stores climbed by 1.1% compared to October 2012.
Year to date, Rite Aid’s same store sales and total drugstore sales are marginally lower, 0.1% and 0.3% respectively, compared to the same period last year. As of October 26, 2013, the company operated 4,599 stores compared to 4,637 stores in October 2012.
Lower Generic Substitution To Aid Revenue Growth But Restrict Gross Margins
The rising proportion of low-cost generic drugs and the declining number of stores has impacted Rite Aid’s top-line growth in the last few quarters as generic drugs are comparatively lower priced than branded drugs. The total generic dispensing rate, which factors the percentage of generic drugs in a consumer’s prescription, grew to 78.5% in 2012, from 74.1% and 71.5% in 2011 and 2010, respectively. Generic drugs continued to replace branded drugs in 2013, albeit at a slower pace.
The introduction of new generic drugs had a 0.85% negative impact on Rite Aid’s pharmacy sales for the month of October 2013, compared to a 1% and 1.6% negative impact in September and August of 2013, respectively. In its latest earnings call, rival firm Walgreen (NYSE:WAG) declared that it anticipates a low rate of introduction of new generics in the first half of fiscal 2014.
Nevertheless, an estimated $15 billion worth of branded products will come off patent in the next three years, opening them to competition from generic drugs. Lower generic substitution will aid revenue growth but can lower Rite Aid’s gross margin growth in the future.