Rite Aid - Key Focus Areas For Its Upcoming Earnings Release

Apr. 9.14 | About: Rite Aid (RAD)

Summary

Higher overall sales, fewer stores, and lower interest expense to aid profitability.

Gross margins are a potential risk.

Recent developments should provide continued growth in 2015.

Rite Aid (NYSE:RAD) releases fourth-quarter and full-year results Thursday morning, and along with management's guidance will provide investors with a treasure trove of information on the company's future. Rite Aid's continues to transform from being a turnaround situation into a growth story. As I wrote in my last article, RAD appears very undervalued compared to its peers, CVS (NYSE:CVS) and Walgreen (WAG), and I am very bullish on the upside potential for RAD's stock price. This article provides some key areas to focus on in the upcoming earnings release and management's conference call with analysts.

RAD has made some outstanding operational improvements in the last couple of years. The company is expected to report a second-consecutive profitable year after several years of losses. RAD reported increased sales and lower selling, general and administrative (SG&A) costs through the third quarter of fiscal 2014 (Q3 FY 2014 earnings). On March 6, 2014, the company reported a 2.2% increase in total sales with 36 fewer stores at quarter end than the prior year. Higher sales and lower store operating expenses should foretell another quarter of improving profitability.

In preparation for Thursday's earnings release and subsequent analyst conference call, I have provided a list of critical areas to review for those who are invested in or follow Rite Aid. The financial results should show another quarter of profitable results and the analyst consensus is 4 cents earnings per share (EPS). I believe there maybe upside to these projections based on the higher overall sales, fewer stores and lower interest expense due to more favorable interest rates and less outstanding debt.

The major risk to RAD's earnings is the potential for lower gross margins. The company's Q3 margins were below last year's and management reduced their full-year profit forecast -- even though their sales guidance was virtually the same. This implies that either gross margins are expected to be lower or SG&A expenses will be higher. On the company's third-quarter analyst call, management noted the "current promotional environment" as being very competitive. RAD's fourth-quarter period from Dec. 1 to March 1, had several noteworthy aspects that led to industry-wide promotions that were heavier than typical periods. The first aspect was a short Christmas shopping season due Thanksgiving falling on Nov. 28 -- the absolutely last calendar date possible.

Retailers, including drug stores were forced to provide unusually high discounts and deals to draw in more shoppers and sales in a shorter holiday season. Open enrollment for Obamacare also began with a January effective date; this was a very significant period for retail drug stores. The first enrollees were expected to be those individuals with pre-existing health conditions that needed coverage. A new pool of customers with chronic conditions and recurring Rx needs would now be able to buy needed prescriptions. RAD, along with all drug stores, spent heavily on advertising and promotions to lure these new customers in the door with the hopes of capturing a loyal (and recurring) Rx customer. My expectation is that gross margins in the current quarter will be slightly lower than Q3, before rebounding in Q1 2015.

Management's quarterly analyst conference call will have a lot of new developments to discuss. All of these developments appear positive for the company's future growth and bottom line. The following noteworthy items should be reviewed for more details in RAD's earnings release and subsequent management conference call:

  • McKesson partnership -- additional details regarding the impact on store inventory, SG&A and Rx costs.
  • Health Dialog acquisition and Rite Aid Health Alliance strategy -- the Rite Aid Health Alliance joint venture with Health Dialog was only in two to three pilot markets for about a year before RAD acquired their partner. The company has not provided many details on their overall strategy regarding this venture, but obviously since RAD bought their partner, they have made a serious commitment to this initiative. I look forward to hearing management discuss their strategic plans for the Rite Aid Health Alliance and this acquisition.
  • Wellness store remodeling and operational performance update - the current number of stores converted to their new Wellness concept and how they are performing vs. traditional stores.
  • Obamacare enrollment impact on sales and margins -- as mentioned, company-wide sales are up with fewer stores than last year, it will be noteworthy to see how much of this was attributed to newly insured individuals.
  • Fiscal 2015 guidance -- historically, the company has provided a low and high guidance for the upcoming year. Depending on how the midpoint of the guidance compares to current analyst estimates, this could be a catalyst for a big move in the stock price.
  • Interest expense and debt refinancing -- the company's improved financial performance has increased RAD's credit worthiness and interest expense should continue to trend lower in 2015. The company may also be able to refinance their long-term debt at a lower interest and extend the maturity date.

This is a very exciting time to be invested in Rite Aid. Management has been executing a turn-around strategy and is now focused on executing a growth strategy. RAD's stock price and valuation is still lower than that of CVS and Walgreen (as I outlined in a previous article.) This earnings release will be a pivotal one to show the market that RAD's operations have truly stabilized and that the company is now focused on creating sustainable growth. I look forward to providing an update upon review of the company's fourth-quarter earnings results and management's conference call.

Disclosure: I am long RAD. 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.