Rite Aid (RAD) was practically written off for dead in 2010. Since 2012 Rite Aid’s stock price has risen from just over a $1 to over $6 a share. This is still off its high of over $8 a share only a few months ago. The recent pullback was caused by a litany of negative news that has produced a buying opportunity for savvy investors — they can get in on the up escalator of a stock that has the economic wind at its back and good fundamental growth.
What Caused the Pullback in Rite Aid Stock?
Rite Aid’s stock price was hit with a series of three negative news announcements, two of which have nothing to do with the performance of the company. RAD stock has fallen from its 52-week high of $8.62 to the about $6.30 today.
On June 5, Rite Aid reported for its quarter ended May 31 and lowered its full-year earnings outlook from between $0.31 to $0.43 cents per share to $0.30 and $0.40 cents per share. In the press release, Rite Aid stated that the reduced guidance was due to slower-than-expected generic purchase price reductions. In other words, the company has not seen the savings from the distribution deal struck with McKesson (MCK) in mid-February. The effects of this delay are not anticipated to affect the rest of 2014.
A 13F report filed by David Einhorn’s Greenlight Capital on July 28 showed that the famed value investor had sold a quarter of its shares in Rite Aid because they had “reached fair value.” Although many people, mutual funds and even other hedge funds frequently follow and try to mirror the investments made by well-known investors, historically, there has not been a statistically significant correlation between company performance and particular institutional ownership. Mr. Einhorn is known to invest in mispriced securities and the movement of Rite Aid from a turnaround play to a growth stock makes it a good time for him to exit his position and growth investors to get in.
On Aug. 6, Walgreen (WAG) announced that it would move ahead with the acquisition of the remaining 55% of the European retailer Alliance Boots. Investors believe that a cross-continent merger of this kind would increase Walgreen’s footprint and provide sufficient buying power to undercut both Rite Aid and CVS (CVS), its two largest U.S. competitors. Although increased power over suppliers will certainly aid the profitability of Walgreen, its impact on the rest of the industry is far from certain — and the downward impact on RAD stock was overblown.
Rite Aid Buying Opportunity
For its quarter ended May 31, Rite Aid’s same store sales increased 3.1% over the prior year. Although front-end sales remained flat, pharmacy sales increased 4.6% with prescription counts up 2.3%. Total drugstore sales increased 2.6% from the same period last year. Prescription drugs account for over 68% of Rite Aid’s sales. As Rite Aid comes to realize the generic drug savings from the McKesson distribution deal over the remainder of 2014, profits will increase as well. Management is being conservative in lowering earnings guidance to give it some wiggle room early to meet targets.
Several industry-specific factors are also working in Rite Aid’s favor. With the passage of the Affordable Care Act, health insurance rolls are anticipated to increase significantly in the coming years. Millions of Americans who were not able to afford health insurance before will now be able to receive benefits. At the same time, baby boomers are rapidly entering their senior years; this age cohort has a higher usage of prescription medications.
In order to fund turnaround efforts Rite Aid took on considerable amount of long-term debt from 2008 through 2012. Since then it has been using its increased profitability to begin to chip away at this balance, with long-term debt declining slightly from last year. This move has lowered interest expense and may make RAD a better acquisition candidate down the road. Although the high leverage is cause for concern, it is manageable and management is making an active effort to decrease its impact in the future.
Take advantage of this buying opportunity to invest in a growth stock now before it is too late.
At the time of publication, Fick had no positions in the securities mentioned.