Rite Aid Falls Despite A Strong Q2’15 As It Lowers Its 2015 Guidance

The third largest drugstore chain in the U.S., Rite Aid (NYSE: RAD) reported its eighth consecutive quarter of profitable growth in net income as well as adjusted EBITDA.  And it posted significant increases in its same-store-sales and prescription count in Q2 2015. However, the company’s stock price has declined by 18.5% because management lowered its fiscal 2015 guidance (mentioned at the end of the article), mainly due to an anticipated decline in reimbursement rates and lower profitability from generic drugs in the second half of the fiscal.

Quick Snapshot of Q2 2015 Earnings

At $6.5 billion, Rite Aid’s Q2 2015 revenue witnessed a 3.9% annual increase mainly on account of higher pharmacy sales. Pharmacy same-store sales increased 5.6%. Net income for the quarter was $127.8 million ($0.13 per diluted share) compared to net income of $32.8 million ($0.03 per diluted share) in Q2 2014. Higher utilization in Medicaid expansion states and the result of Rite Aid’s pharmacy initiatives led to a 4.1% growth in total comparable store sales. Front-end same-store sales increased by 1.1%.

Rite Aid continues to focus on its store re-modeling initiative, efficient cost management and customer loyalty programs to spur its future growth. Controlling costs and making operational progress remain key focus areas for the company. In addition to expanding its healthcare offering, Rite Aid is making progress in building up its real estate pipeline to execute its relocation and new store program over the next several years. As of August end, Rite Aid operated 4,572 stores.

View our detailed analysis for Rite Aid

Pharmacy Margins To Decline In The Second Half Of Fiscal 2015

Rite Aid’s gross margin in the quarter improved marginally, from 28.9% in Q2 2014 to 29.0% in Q2 2015, due to the favorable impact of the inventory valuation related to the transition to its new drug purchasing and delivery arrangement with McKesson.  Pharmacy gross profit dollars in Q2 2015 were higher but the margin rate was lower, compared to Q2 2014. Pharmacy gross profit was positively impacted by both a higher prescription count and the benefits of the purchasing agreement with McKesson; on the other hand, it was negatively impacted by continued reimbursement rate pressure.

Based on the current estimates for reimbursement rates, anticipated lower profitability due to a delay in the introduction of a generic equivalent to Nexium, and higher costs for generic drugs that recently lost their exclusivity, Rite Aid expects the pharmacy gross margin in the second half of fiscal 2015 to decline compared to the same period last year. The company has accordingly lowered its guidance for adjusted EBITDA, net income and earnings per diluted share.

Agreement With McKesson Will Increase RiteAid’s Purchasing Power

Rite Aid recently announced an expanded tie-up with McKesson Corporation (MCK), the largest distributor of pharmaceutical and medical supplies in the U.S., to source and distribute generic pharmaceuticals for Rite Aid. It claims that the continued implementation of its new drug purchasing and distribution process with McKesson was one of the most significant initiatives it focused on in Q2 2015. Rite Aid has now completed the conversion of all its stores and four pharmacy distribution centers to this new distribution process. The company believes the new process will provide it with working capital benefits and improved customer service through a better in-stock position.

The agreement with McKesson, which has been extended until March 2019, is expected to lower the purchasing cost of generic drugs for Rite Aid, providing the company with long term drug savings. The expanded partnership offers significant working capital benefits by providing Rite Aid pharmacies with direct to store delivery five days a week. Rite Aid believes the partnership will allow it to achieve supply chain efficiencies and derive additional cash flow to fuel long term growth. It claims that the agreement is generating purchasing savings that are in line with its expectations.

Rite Aid on a standalone basis has an estimated generic purchasing power of $1.5 billion, which is significantly lower than its peers. ^[1]

Revised Fiscal 2015 Guidance

– Total sales between $26.0 billion and $26.3 billion vs its previous guidance of $26.0 – $26.5 billion.

– Same-store-sales to increase 3% to 4%.

– Adjusted EBITDA to be between $1.20 billion and $1.28 billion, compared to its initial estimate of $1.28–$1.35 billion.

– Net income in the range of $223 million to $333 million, as compared to the initial guidance of $298 – $408 million.

– Earnings per diluted share between $0.22 to $0.33, down from the earlier forecast of $0.30 to $0.40.

– Capex of $525 million.

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1. CVS Caremark’s CEO Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, August 6, 2013 [↩]