Rite Aid New Coverage $1.38: New Formats and Initiatives Drive Growth
Rite Aid (NYSE:RAD), the third largest retail pharmacy chain in the U.S. with over 4,700 locations, is aggressively focusing on improving its bottom line and same store sales metrics to regain profitability. In April 2010, it rolled out its Wellness+ loyalty program to improve customer retention, increased average ticket size and it crossed 36 million members within a year. Rite Aid sells both prescription and non-prescription drugs as well as retail merchandise such as cosmetics and food. Rite Aid competes with Walgreens (NYSE:WAG), CVS Caremark (NYSE:CVS) and Wal-Mart (NYSE:WMT).
We value Rite Aid at $1.38 Trefis price estimate of its stock, which is about 35% ahead of the current market price.
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Prescription drugs sales constitute the main revenue source for Rite Aid and contribute around two-thirds of the stock value. Below we highlight a few of the key drivers to the business.
Seniors Spending on Drugs
The U.S. has an aging population, and as these seniors spend more on drugs, the prescription drugs market in the U.S. is expanding rapidly. The 2010 U.S. health reform legislation is expected to increase prescription drug sales as over 30 million so-far uninsured Americans will gain coverage along with the expansion of Medicaid and Medicare Part D plans.
The expansion of generic drugs in the U.S. market will positively impact retail pharmacy gross margins. Generic drugs have lower costs but higher margins compared to branded drugs and gross profit dollars are approximately 50% higher on generic drugs than on branded drugs. Patents for a large number of branded drugs, for example Pfizer’s blockbuster Lipitor drug, will expire soon. The generic wave will be a huge catalyst to boost industry margins.
Wellness+ Program, Improving Store Layout to Drive Sales
Rite Aid is keenly focusing on raising its same store sales by improving customer retention and average ticket sizes in order to regain profitability. It rolled out a Wellness+ card-based loyalty program in April 2010. The scheme has gained early traction and crossed 36 million members in April 2011, which accounted for 67% of the front-end sales and 58% of prescriptions filled.
Wellness+ members have higher spending levels on average than non-members and a much higher rate of prescription retention. The Wellness+ program improved sales trends in 2011 and Rite Aid plans additional investments in the program. This is likely to expand its membership and further boost prescription, OTC and merchandise sales.
In order to improve sales per unit area of retail space, Rite Aid has been liquidating unprofitable stores and remodeling others. The number of retail drugstores has declined from over 5,000 in 2008 to 4,700 in 2011 and Rite Aid will close another 60 this year. It will remodel 500 stores by 2012 and the entire chain over the next 5 years.
Rite Aid is also building a segmentation strategy and experimenting with different store formats like Wellness, Save-a-Lot and Value formats for better tailored to the needs of the particular market depending on where the store is located. These will also have an expanded selection of organic foods, personal care products, homeopathic medicines and pharmacy services. These efforts have started helping Rite Aid turnaround and have pushed up the comparable same store sales by over 3% last quarter.
Stiff Competition is the Biggest Threat
Rite Aid faces significant competition from pharmacy leaders Walgreen and CVS, both of which are much much bigger than Rite Aid and so have better customer reach and are further ahead in programs like having associated wellness clinics.
More recently other retailers like Wal-Mart are becoming more competitive in the pharmacy and health business. For example, it began selling over 360 generic drugs for only $4 per subscription — significantly less than Rite Aid’s prices that puts pressure on its margins. This also affects Rite Aid’s efforts to increase the sales of other front-store products such as beauty products, snacks and groceries that are heavily dependent on its ability to cross-sell customers who come in for prescriptions.