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Shares of Rite Aid Corporation (RAD) continue their impressive move upwards. Shares have risen some 30% over the past week alone as investors are cheering on the back of a strong earnings report.

After witnessing year to date returns of 250%, the stock is still trading at a huge discount to some of its competitors, partially because of the large debt position.

I remain cautiously optimistic for the long term prospects.

Second Quarter Results

Last week, Rite Aid reported its second quarter results. The company generated second quarter revenues of $6.28 billion, up 0.8% on the year before. Revenues came in line with consensus estimates which stood at $6.27 billion.

The company turned a $38.8 million loss into a $32.8 million profit. Earnings attributable to shareholders came in at $30.0 million, resulting in earnings per share of $0.03. Analysts were on average looking for a loss of $0.04 per share.

CEO and Chairman John Standley commented on the quarterly performance, "We posted excellent results in the second quarter, highlighted by another quarter of net income and an all-time company record for second-quarter Adjusted EBITDA."

Looking Into The Results...

Rite Aid had a solid quarter, as a 1.0% increase in same store sales is quite a good result for the troubled company, partially offsets by store closures.

Gross margins rose sharply by some 150 basis points to 28.9% of total revenues. At the same time, selling, general & administrative expenses fell by almost 50 basis points to 28.9% of total revenues.

All in all, adjusted EBITDA spiked up almost two percent points to $342 million, equivalent to 5.4% of total revenues. As the company took a $62 million charge on debt retirement, net earnings growth was less spectacular. Rite Aid had a $23.5 million benefit on the settlement of a prescription drug antitrust case.

All in all, net income rose to 50 basis points of total sales. This compares to losses equivalent of 60 basis points of total revenues last year.

...And Into The Remainder Of The Year

Rite Aid sees full year sales between $25.1 and $25.3 billion, as comparable store sales are expected to range between a 0.5% decline and 0.5% growth.

Adjusted EBITDA is seen between $1.24 and $1.30 billion, while diluted earnings are seen between $182 and $268 million. This would result in earnings between $0.18 and $0.27 per share.

Analysts were looking for full year earnings of around $0.13 per share, after the company previously guided for earnings between $0.10 and $0.15 per share. Previously, Rite Aid guided for full year revenues of $24.9 billion to $25.3 billion.

Valuation

Rite Aid ended the second quarter with $144.2 million in cash and equivalents. The company torsos alone a very sizable debt position of little over $6.0 billion including finance leases, for a net debt position of around $5.9 billion.

Revenues for the first six months of the fiscal year came in at $12.57 billion, down 1.0% on the year before. A $66.9 million loss last year turned into a $119.7 million profit. At this pace full year revenues of around $25 billion should be attainable, while the company could report earnings of around $225 million.

Trading around $4.70 per share, the market values Rite Aid at $4.3 billion. This values the equity in the firm at 0.2 times annual revenues and 19 times annual earnings.

Given the cautious steps to return to profitability, and the large debt position, Rite Aid does not pay a dividend at the moment.

Some Historical Perspective

Long term holders in Rite Aid have seen poor returns, although they have faired slightly better in recent times. Over the past decade shares are trading with losses of around 10%, after trading as high as $6 in 2007. Note that shares traded around $50 back in 1999.

For more recent investors, in particular those who picked up shares at $0.25 back in 2009, Rite Aid has given a great opportunity to achieve some decent returns.

Over the past years, annual revenues have stagnated around the $25 billion mark. After reporting large losses in recent years, the company has regained its ability to turn a profit.

Investment Thesis

Rite Aid is recovering from year's of poor results, but is benefiting from two major trends.

Under command of CEO Standley the company is remodeling its stores into wellness centers with expanded pharmacy services and other healthy products. At the moment, the company remodeled little over a 1,000 stores, or roughly a quarter of its 4,600 store base into these wellness centers. This is paying off in the form of superior same store sales results.

The other benefit are new generic medications which boost gross margins. Retention rates were strong as well, despite having acquired patients on the back of the Express Scripts (ESRX) and Walgreen (WAG) dispute.

Another interesting development is that several million currently uninsured healthcare households live in Rite Aid's area. They will benefit from the new or expanded coverage under the Affordable Care Act, starting in 2014.

The third largest drugstore chain is competing with giants like CVS Caremark (CVS) and Walgreen. The firm has been struggling after buying Brooks and Eckherd back in 2007. With its $25 billion in annual sales it is much smaller compared to the two industry giants, but it trades at a discount as well.

CVS is valued around $71 billion, valuing the business at nearly 0.6 times annual revenues of $123 billion. CVS is valued around 18 times last year's earnings. Walgreen's current valuation of $53 billion, values the business at 0.75 times annual revenues and 25 times annual earnings.

So while earnings multiples are in place, Rite Aid trades at a huge discount to its main competitors, even after witnessing year to date gains of 250%. While the momentum has been insane, the long term potential is definitely still there.

Source: Rite Aid: Long Term Appeal As Earnings Improvement Show Relative Undervaluation