Rite Aid Q2 Earnings Preview: Acquisition Synergies Likely Improved Margins, Amidst Sales Slowdown

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Rite Aid

The third largest drugstore chain in the U.S., Rite Aid (NYSE:RAD), is about to announce its earnings for the second quarter of FY 2016 (ending August) on September 17th.   [1]  In the previous quarter, the company continued growing sales at the prior-year growth rate of approximately 3%, driven by increases in same-store sales and same-store prescription count. Despite an increase in operating expenses, Rite Aid managed to hold margins steady.

In this quarter, while sales growth seems to have slowed a bit, the company generated those sales at better margins, in our view. The slowdown in generic price inflation and benefits arising from the company’s acquisition of EnvisionRx are the key factors that likely provided a boost to Rite Aid’s gross margins. While the net effect of these trends on the bottom line will only be known after the earnings release, in this article we will discus each of the influencing factors in more detail.

Our price estimate for Rite Aid currently stands at $8.74 per share, which is slightly above the current market price.

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View our detailed analysis for Rite Aid

Generic Launches Drag Sales Growth

Growth in same-store sales has taken a hit this quarter. According to Rite Aid’s monthly sales releases [2], year-over-year growth in same-store sales averaged at 2.1% this quarter (Jun to Aug) compared to 3.5% during the five previous months (Jan to May). Some of this decline can be explained by the increase in the impact of generic introductions on the company’s pharmacy sales. Generics, being cheaper than their branded versions, have a negative impact on pharmacy sales as more of them are introduced. The negative impact of new generic introductions on pharmacy sales has doubled thus far in 2015, from 1.1% in January to 2.2% in August.

 

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As the number of branded drugs losing patent protection likely peaked this year, we expect sales growth to recover hereafter. Moreover, a pick up in the launch of specialty drugs is likely to increase revenue per prescription, driving sales upwards. Approximately 50% of new molecular entities and new therapeutic biologics that the FDA approved this year fit the commonly used definitions of specialty products [3]. This trend is expected to continue through 2015 and spending on specialty drugs alone is expected to quadruple by 2020.

Margins Likely Increased Driven By EnvisionRx Synergies

In February this year, Rite Aid acquired EnvisionRx, a US-based pharmacy benefit management (PBM) company. It was expected to provide Rite Aid access to the latter’s mail-order channels as well as increased exposure to specialty pharmacy. Most importantly, access to millions of individuals that EnvisionRx manages will likely result in significant savings on drug acquisition costs.

EnvisionRx is a very small PBM with revenue of $5 billion, compared to market leaders Express Scripts (NASDAQ: ESRX) and CVS Health (NYSE:CVS). Nevertheless, it is a high-growth business that grew sales by 250%, from less than $2 billion in 2011 to an estimated $5 billion in 2015. As Rite Aid gains access to the 13 million individual accounts that EnvisionRx manages, [4] it will benefit from the increased negotiating power with drug manufacturers and therefore lower drug acquisition costs.

We believe this factor has already started to play out, as Rite Aid’s margins stayed at 4.5%, last quarter, despite increased operating expenses due to RediClinic expansion and the roll-out of a new customer loyalty program. What remains to be seen is whether the margin expansion is enough to offset the slowdown in sales and maintain earnings growth in the second quarter.

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Notes:
  1. Rite Aid Investor Relations []
  2. Rite Aid News Releases []
  3. American Pharmacists Association []
  4. 6 Ways Rite Aid’s Acquisition Of EnvisionRx Will Take Its Stock Higher, Seeking Alpha, February 11, 2015 []