Rite Aid Raises Its 2015 Outlook Backed By A Strong Q3 2015

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Rite Aid

The third largest drugstore chain in the U.S., Rite Aid (NYSE: RAD) saw its stock price increase by more than 10% as the company exceeded its own expectation and beat wall street estimate in Q3 2015 (reported on December 18th). Rite Aid raised its guidance for fiscal 2015 (mentioned at the end of the article) on account of the stronger than expected performance in the quarter, after lowering it last quarter.

A Quick Snapshot Of The Q3’15 Earnings

At $6.7 billion, Rite Aid’s Q3 2015 revenue was 5.3% higher compared to Q3 2014. The increase was mainly driven by a 5.4% year-on-year jump in total same-store sales, which in turn was fueled by a 4.5% year-on-year increase in same-store prescription count on account of higher utilization in Medicaid expansion states, the success of RiteAid’s various pharmacy initiatives, and an increase in flu shots administered during the quarter. Rite Aid’s front-end same-store sales increased by 1.6% annually. Pharmacy same-store sales were higher by 7.2%, which included an approximate 228 basis point negative impact from new generic drugs.

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Rite Aid saw its gross margin improve from 28.3% in Q3 2014 to 28.7% in Q3 2015, as the continuing reimbursement rate pressure was offset by a lower LIFO charge and cost reductions from the company’s purchasing arrangement with McKesson. Operating income and net income increased by 33% and 47% year on year, respectively, as Rite Aid focused on managing expenses to effectively leverage its top line growth.

Our price estimate of $5.66 for Rite Aid is approximately 15% lower than the current market price. We are in the process of updating our model for the Q3 2015 earnings release.

View our detailed analysis for Rite Aid

The New Drug Distribution & Purchasing Process With McKesson Eases Pressure Off Margins

Q3 2015 was the first full quarter of Rite Aid’s conversion to the new distribution process with McKesson, the largest distributor of pharmaceutical and medical supplies in the U.S. The tie-up with McKesson provides Rite Aid with purchasing efficiencies and direct-to-store delivery for all its pharmacy products. Rite Aid converted all its stores and four pharmacy distribution centers to this new distribution process by early Q3 2015. With all its stores receiving direct-to-store delivery five days a week, the company expected to generate working capital benefits and improved in-stock positions to better serve its customers. In Q3 2015, the distribution process yielded savings and benefits that were in line with Rite Aid’s expectations. The company expects a working capital benefit of approximately $250 million as a result of the McKesson agreement in fiscal 2015.

Even though Rite Aid expects the reimbursement rate pressure to continue to pose a challenge in the future, we believe that the cost savings from the new distribution and purchasing process with McKesson will help ease pressure off the company’s bottom line.

Expanding Healthcare Offering To Provide A Higher Level Of Care

Rite Aid believes that its long-term strategy centers around the continued expansion of its healthcare offering, and it claims to have made significant progress in this area during Q3 2015. The company continues to strengthen its portfolio of health and wellness services. Some of the examples are:

– Expanding efforts around flu administration: Rite Aid has administered more than 3 million flu shots so far this year. The company is working diligently to engage patients by educating them about the value of this convenient health and wellness service. In addition to flu shots, it believes that raising awareness about other immunizations represents a great opportunity to help protect the health of the communities. To capitalize on this opportunity, Rite Aid launched a comprehensive offering of tools and resources known as Vaccine Central, in Q3 2015. Through Vaccine Central, customers can visit Riteaid.com or any Rite Aid store and take a comprehensive immunization evaluation that helps determine their specific vaccination needs.

– Quit for you smoking cessation program: This is a free program initiated which offers counseling by Rite Aid pharmacists to help customers develop and complete a personalized quit plan. The program empowers the pharmacists to provide additional care beyond prescriptions. The company claims that the customer engagement in the program has been encouraging so far. It plans to launch further enhancements to Quit For You in time for the New Year’s quit season, including personalized text message support for quit tips and positive affirmations. It is also enhancing its online support available at riteaid.com by adding video tutorials, a quit calendar and an evaluation tool to identify customers’ best nicotine replacement therapy option.

– Adding HealthSpot stations to select stores: Rite Aid announced a new initiative in Q3 2015, which bring private walk-in HealthSpot stations to select Rite Aid stores in three Ohio markets in the near future. Though these conveniently accessible health stations, customers will be able to use videoconferencing and interactive medical devices to connect with medical professionals and be treated for common health conditions. A key benefit is that most insurance plans will be accepted for these appointments.

Wellness Store Remodel Program Is At The Center Of Rite Aid’s Growth Strategy

Rite Aid believes that it is doing a good job in executing the store remodels as it builds up its real estate pipeline to support relocation and new store initiatives over the next several years. Wellness stores continue to outperform the non-wellness stores in terms of same-store front-end sales and script counts. In Q3 2015, front-end same-store sales in wellness stores that have been remodeled in the past 24 months were approximately 321 basis points higher than the non-wellness stores, and script growth in these stores was 278 basis points higher. A key growth driver for the Wellness format is the higher level of service provided by more than 2,000 wellness ambassadors. The company is also in the process of expanding the level of service that it provides in the beauty category. It has 50 Wellness stores with expanded beauty departments that feature a broader selection of prestige brands and specially trained beauty advisors.

At the end of Q3 2015, Rite Aid has a total of 1,529 Wellness stores, which is more than a third of its total store base.

Fiscal 2015 Outlook

– Total sales between $26.25 billion and $26.40 billion.

– Adjusted EBITDA between $1.28 billion and $1.31 billion.

– Same-store-sales growth in the range of 3.75% to 4.25%.

– Net income in the range of $315 million to $370 million.

– Earnings per diluted share in a range of $0.31 to $0.37.

– Capital expenditure of approximately $525 million, with approximately $250 million related to remodels and approximately $100 million for file buys.

– Free cash flow in the range of $325 million to $375 million.

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