Rite Aid (NYSE:RAD) stock is up 64% year-to-date through April 15 — the first time it has traded above $2 since September 2009. Its latest earnings report seems to indicate the drugstore chain has turned a corner, but should investors be jumping on the bandwagon?
To see, let’s take a look at the pros and cons:
Profitability: On April 11, Rite Aid announced its first full-year profit in six years. The third-largest drug store chain in the country went from a loss of 43 cents per share in 2012 to a profit of 12 cents. And in fiscal 2014, it expects to earn anywhere from 4 cents to 20 cents per share. The turnaround was fueled by a 3.4% increase in the number of prescriptions filled along with higher gross margins from generic drugs.
Long-Term Debt: The company refinanced $2.4 billion of its debt, meaning all of its debt now matures in 2017 or later. In addition, it repaid $250 million in fiscal 2013 and intends to increase that amount in 2014. By refinancing its debt, Rite Aid expects to save $49 million in cash annually, which should translate to 4 cents in earnings this year. Most importantly, its leverage ratio (total debt less invested cash, divided by latest 12 months’ adjusted EBITDA) has improved to 5.3 from 6.6 in the fourth quarter of 2012.
Wellness: Of all the commentary I’ve read about Rite Aid’s fourth quarter, the most encouraging news is the success of its wellness stores. The original format was introduced in 2011, and there are now 797 stores in place with 400 remodels expected in fiscal 2014. Rite Aid’s Wellness+ loyalty program now has 25.2 million active members (meaning they have used their loyalty card twice in last 26 weeks) who accounted for 79% of front-end sales and 68% of prescriptions filled during the fourth quarter. Most notably, its wellness stores delivered front-end same-store sales growth in Q4 that was 300 basis points higher than at stores that weren’t remodeled. Two years in, the format is clearly a success.
Total Debt: Reducing its leverage ratio is good a start, but that doesn’t do anything about the overall level of debt. Its capitalization ratio is currently 150% compared to 20% for CVS Caremark (NYSE:CVS). Assuming that Rite Aid plans to continue remodeling the 3,800 or so stores that haven’t been converted to the wellness format, it’s hard to imagine the company making more than a small dent in its debt. It just paid down $250 million in 2013; using 100% of its free cash in 2014 to pay down debt ($700 million), it would reduce its long-term obligations by about 12%. But I doubt Rite Aid can keep growing free cash flow by 40% a year.
Prescriptions: Rite Aid’s same-store prescription count for March grew by 0.3% year-over-year. In February, it also grew by just 0.3%. Both of these numbers pale in comparison to January’s 5% increase, December’s 4.4% jump and November’s 2.2% increase. And if you exclude flu shots, the January and December increases were only 1.6% and 2.7%, respectively. We’ve probably seen the end of the gains RAD made in fiscal 2013 when former Walgreen (NYSE:WAG) customers moved over to get their prescriptions filled. Now that Walgreen’s back in bed with Express Scripts (NASDAQ:ESRX), you can expect some customers to return to Rite Aid’s bigger rival.
‘Obamacare’: An additional 30 million people are in line for insurance coverage come Jan. 1, 2014. Many of the newly insured will seek out a pharmacy to fill their prescriptions. CVS and Walgreen possess a combined 16,000 store locations across the U.S. compared to about 4,600 for Rite Aid, which means convenience alone will likely bring them to CVS or Walgreen. Two-thirds of Rite Aid’s revenues come from prescriptions, so revenue and earnings growth potential is somewhat limited if it can’t secure a bigger slice of the pie. While its wellness stores should continue to deliver profitability, smaller store numbers put Rite Aid at a big disadvantage.
This is a really tough decision. While it’s obvious Rite Aid is making big strides operationally, it’s also clear that its competitive position isn’t very strong. Its peers are much better financed and better positioned to handle whatever Obamacare delivers.
Furthermore, Rite Aid needs two or three years of outstanding success for its stock to return to the halcyon days when it routinely traded above $5. The declining growth of its prescription count is definitely worrisome. Its margin gains from generics will slowly ebb, and when that happens, it’s hard to predict whether its front-end will be able to pick up the slack.
So, should you buy RAD?
Not as a main player in your portfolio. However, if you feel like rolling the dice and can afford to lose the bet, I’d see no harm in making a very small discretionary investment. It definitely has some upside potential. The question is — how much?
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.