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The third largest drug store chain in the U.S., Rite Aid Corp. (NYSE:RAD) has been delivering healthy financial performance over recent quarters, which is likely to continue due to the company's cost-control efforts and solid operational execution. Also, margins continue to expand and valuations remain attractive for RAD. Moreover, analysts have projected a healthy next five-year growth rate of 8% per annum. Therefore, I believe RAD is a good investment opportunity.

The company posted positive earnings and registered an earnings beat for the recent second quarter. Due to the quarter's solid results, the stock continued to outperform on Thursday, last week, as it was up 23.5% as compared to a -0.2% drop for the S&P 500. The stock has also outperformed the broad market in the ongoing year (2013); RAD's stock is up 235% YTD in comparison to an increase of 22% for the S&P 500.

Financial Performance

The company reported net revenues of $6.3 billion, up approximately 1% year-on-year. Revenues for the quarter were driven by improved comparable store sales, which were up 1% year-on-year. RAD also marked an earnings beat of 175% for the recent second quarter by delivering an EPS of $0.03, up 160% year-on-year. For the recent second quarter, RAD was able to increase EBITDA by 45% to $318 million, beating analyst consensus estimates of $238 million. Strong earnings for the quarter were driven by solid operational execution, cost control efforts and low interest expense.

The company has been consistently delivering solid financial performance in recent quarters. In the last four quarters, the company has been able to mark three earnings beats; all three times its stock price increased more than 15% on the day of the quarterly earnings release.

Since the last two years, the company has been working to improve upon its cost structure, which has had a positive impact on the company's earnings. Also, the company's margins have improved in recent quarters despite the prevalent competitive environment in the industry. RAD has been facing intense competition within the industry, from large rivals like Walgreen Co. (NYSE:WAG) and CVS Caremark Corp (NYSE:CVS), as companies within the industry are offering more discounts to increase their revenues and drive up customer traffic. RAD seems to be doing good to survive the ongoing competition, which is evident by its improved recent quarter performance.

As the industry business environment remains competitive, RAD has been improving upon its cost structure to grow its earnings. RAD's cost control efforts seem to be delivering the desired results, as margins have consistently increased over recent quarters.

2Q FY2013

2QFY2014

Gross Margin

27.5%

28.6%

EBITDA Margin

3.5%

5%

Operating Margin

1.6%

3%

Source: Company Reports and Calculations

RAD has also been working on remodeling its existing stores, and so far it has remodeled nearly 22% of its existing stores. In the recent second quarter, it remodeled an additional 114 stores, bringing the total remodeled stores count to 1,019. By the end of the ongoing fiscal year (2014) and FY2015, total remodeled stores are likely to increase to 1,200 and 1,650, respectively.

Guidance

On the back of a better-than-expected financial performance for the first half of FY2014, the company raised its full year (FY2014) guidance for adjusted EBITDA, net income and EPS. The company's management now expects its full year adjusted EBITDA to be $1240-$1300 million, as compared to the previous guidance range of $1090-$1175 million. Its EPS guidance range was increased to $0.18-$0.27 from the previous guidance range of $0.01-$0.16. Also, the management expects soft earnings for the second half of FY2014, as compared to the first half of the year, mainly due to reimbursement rate pressure and drug cost hikes. However, I believe a decline in earnings in the second half will be modest due to RAD's solid operational execution, margin improvement and a scheduled reaccelerating generic launch in 4Q FY2014.

Risks

Despite the fact that the company has delivered improved financial performance in recent quarters, the company continues to face risks that threaten its earnings potential. Competition within the industry from large rivals like WAG and CVS remains a risk to the company's earnings potential in the short and long terms. Also, drug inflation and rate pressures remain a threat to the company's financial performance.

Conclusion

RAD has been delivering improved financial performance in past quarters. I believe the trend of improving performance will continue moving forward, as the company works on cost control efforts and maintains is solid operational execution. Also, I believe the stock is trading at attractive valuations, despite a 235% year-to-date stock price increase. RAD has attractive P/S, EV/EBITDA and EV/Revenue in comparison to WAG and CVS. Due to the abovementioned factors, I believe RAD offers a good investment opportunity and I have a bullish stance on the stock.

P/S

EV/EBITDA

EV/Revenue

RAD

0.17x

7.50x

0.40x

WAG

0.75x

12.0x

0.80x

CVS

0.60x

8.0x

0.65x

Source: Yahoo Finance

Source: Competition Fails To Bring Down Rite Aid's Solid Streak