Rite Aid (NYSE:RAD), the third largest drugstore chain in the United States, reported its first quarterly profit in almost five years in December 2012. The company had net loss margin of -1.5% on annual sales of $26 million US in 2012. The company gained big as a result of a dispute between Walgreen (NYSE:WAG) and Express Scripts. It has now reported script count growth for eight consecutive quarters with growth in the last three quarters outpacing the previous five by a margin. The growing introduction of generic drugs which have larger gross margins have helped the company turn profitable as it navigates through a huge debt.
Rite Aid has been under huge debt after its acquisition of Brooks and Eckerd stores. The deal, which added another $850 million in debt to Rite Aid, happened in 2007, right before the global economy crisis. Buoyed by the success of its turnaround efforts, the company recently raised forecasts for 2013. Below we take a look at the company’s prospects in 2013.
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Generic To Drive Profitability
One of the primary driver for the company’s turnaround was generic introductions. Generics carry a higher margin than branded drugs with the difference at times being as much as 15% of the sale price.  With Obamacare expanding insurance coverage to several million of previously uninsured Americans, the demand for lower-cost forms of medication is expected to shoot up. The demand will be further helped by blockbuster drugs with a combined worth of $170 billion going off patent by 2015.  The low cost factor would drive further generic adoption. Generics penetration across Rite Aid stores crossed the 80% threshold in the quarter ending November 30.
Wellness+ Loyalty Program And Store Format Conversion
The company closed several under-performing stores and remodeled hundreds to improve consumer adoption of its service in 2012. It had set a goal of having nearly 800 wellness stores by the end of fiscal year 2013 and converted an additional 114 stores in the third quarter bringing up the total number of converted stores to 687. The company operates about 4,650 stores and almost 18% of its stores are now operating under the new format.  These stores are manned by Wellness Ambassadors who are trained to provide customers a one-of-a-kind-shopping experience. The stores have had a positive impact on the sales so far, and we expect the company to continue these conversions to build on its wellness+ customer loyalty program in order to develop loyalty among customers.
The company has also put a lot of emphasis on its loyalty program. The wellness+ program had approximately 25 million active members, defined as those who have used their card at least twice in the past 26 weeks.  The number represents a 5% increase over the same period the previous year and signals the growing loyalty towards the Rite Aid brand. These participants accounted for 76% of stores sales and 67% of prescriptions filled in Q3 2013.  Increased loyalty would further support a growth in same store prescription count and front end sales over the coming quarters.
Positive Reception of Rite Aid’s Private Brand
The company is promoting its new Rite Aid brand architecture to lure customers into purchasing Rite Aid branded products. The company converted 2,900 items to the new architecture last year and followed it up with conversion of seasonal private brand items this year. This has helped it grow private brand penetration to 18%, an increase of 1.3% over the prior year period. The private brand products carry higher margins and should help the company succeed in its crusade for margin improvement.
We have a $1.50 Trefis price estimate of Rite Aid which is at par with the market price.Notes: