Rite Aid: Stock Could Rise 40% Due To A Turnaround

| About: Rite Aid (RAD)

After more than 5 years of losses, Rite Aid (NYSE:RAD) finally reported its first quarterly profit. Rite Aid is the number 3 drugstore chain after CVS and Walgreen (WAG). Rite Aid has been in trouble 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 turned south.

With a decline in consumer spending and a rise in debt, Rite Aid was stuck. The company had to cut costs and refinance debt. Rite Aid is now finally seeing sales growth again. The company earned a net income of $60.5 million or 7 cents a share. Analysts were expecting a loss of 3 cents per share.

I believe this may show that the company may finally be in the midst of a turnaround. There are many strong growth drivers going forward for the company. One of the biggest reasons for the increase in gross profit was due to stronger generic drug offerings.

Generic drugs tend to have higher margins relative to their name brand counterparts. Patients are switching to lower-cost forms of medication to cut back on expenses.

Rite Aid's growth strategy has been working well for it so far. The company closed underperforming stores and has remodeled several hundred. The company has also put a lot of emphasis on its loyalty program. The Wellness+ loyalty program has 25 million active participants. These participants accounted for 76% of stores sales and 67% of prescriptions filled. It's a great strategy aimed to attract and retain shoppers.

Rite Aid has also pulled in a good chunk of business from Walgreen. Rite Aid and CVS are benefiting from a large dispute by Express Scripts (NASDAQ:ESRX). Walgreen and Express Scripts have been disputing related to terms of their contract. Walgreen saw profit decline 25 percent mainly due to a loss of customers from Express Scripts. These customers will be migrating to Rite Aid and CVS.

Rite Aid has also raised its guidance for FY 2013 and now expects a loss of 5 cents per share to a profit of 3 cents per share. While there are concerns over a decline in SSS growth. We need to understand why the decline is happening. Since generic drugs are priced cheaper than name brand drugs, the sales will be lower, but the important part the SSS growth figure fails to reflect is the margins. The higher margins in generic drugs will translate to a stronger bottom line.

The quarter's earnings would have been much better, but Hurricane Sandy impacted its sales. 800 of the company's 4,600 stores were closed for several days due to the hurricane. If these stores were open, I imagine that the company would have seen a slightly better EPS. I also believe that these stores will be instrumental in helping the company achieve a profit next quarter.

Rite Aid is in the midst of a strong turnaround. The company has finally reported a profit after five years. As consumers spend more money on generic drugs, Rite Aid will benefit from higher margins. While the stock is up 26% after reporting earnings, there is still plenty of upside.

If Rite Aid is able to generate an EPS of 20 cents per share, the stock could easily rise to $1.80 per share. Given that the company earned 7 cents this quarter, with the impact of Hurricane Sandy, it is not unthinkable for the company to earn 20 cents for a full fiscal year. A $1.80 price target implies a 40% return. I believe Rite Aid provides investors with an attractive opportunity.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.