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Summary

  • Rite Aid scares investors by already lowering the guidance for this year.
  • This is after shares had nearly tripled over the past year.
  • Strong momentum left shares vulnerable for a set back, I am a buyer on significant dips.

Investors in Rite Aid (RAD) had a difficult week after witnessing strong momentum this year and in 2013.

The company released its May sales results and already had to revise its full year earnings guidance. This is while the company has not even released its official first quarter results yet.

After the very strong momentum, shares are vulnerable for a little correction, although operational improvements continue to materialize. This makes me a buyer on significant dips.

Disappointing May Results

Rite Aid reported total drug store sales for the five weeks ending on May 31 which came in at $2.48 billion. This is 2.5% higher compared to last year.

Sales growth has been fueled by a 3.5% increase in comparable store sales. Pharmacy same store sales rose by 5.0% while front-end same store sales were up by just 0.5%.

Preliminary Quarterly Results

Rite Aid has gathered preliminary results for the past quarter while definitive results will not be released until June the 19th. Based upon disappointing pharmacy trends notably in the month of May, earnings and EBITDA will be under pressure.

Adjusted EBITDA is now seen between $275 and $285 million while net earnings are seen at $35 to $45 million, which would translate into GAAP earnings of $0.04 per share. The earnings guidance is much lower than current consensus estimates with analysts looking for first quarter earnings of $0.08 per share.

Higher than expected costs due to a delay of expected generic purchase price reductions, and greater cuts in reimbursement rates, put pressure on profitability.

2015 Will Be Softer Than Anticipated

Based on the disappointing month of May and the generic price reductions which are anticipated for the remainder of the year, Rite Aid is forced to already lower its full year outlook. This comes after the company has not even reported the definitive results for the first quarter yet.

Adjusted EBITDA is now seen between $1.275 and $1.350 billion which should translate into earnings of $298 to $408 million. This implies that GAAP earnings are now seen between $0.30 and $0.40 per share. The previously issued guidance for sales and comparable store sales is unchanged.

The actual cut in the earnings guidance for the full year is modest, after Rite Aid guided for earnings of $0.31 to $0.42 per share back in February.

Emerging, After Long Term Struggles

Back in April, Rite Aid updated the market with its investor presentation. The company operates some 4,581 stores across the US with exception of many states between the coasts. Those stores fill 295 million scripts every year as Rite Aid aims to benefit from the aging population. Combined with the increase of people having coverage provided by the Affordable Care Act, the opportunities for the firm are increasing by the day.

After struggling for years, the company is making a turnaround. The company is reinvigorating topline revenue growth. At the same time initiatives like wellness plus and the company's cards will boost customer loyalty while the company remains focused on managing costs. While leverage is rather high, no significant amounts of debt are due before 2018.

Note that in the period 2010-2012, Rite Aid still posted losses ranging from $369 million to $555 million. The company managed to return into the black figures by 2013 to post a $249 million over the past year. Part of this success has been driven by the popular wellness plus and loyalty card rewards.

Besides these initiatives, Rite Aid also expanded its relationship with McKesson (MCK) which will source and distribute generic pharmaceuticals for the company in an agreement which has been extended till March of 2019. Lower purchasing costs and an improvement of working capital are anticipated following the deal.

Valuation

After the correction equity in the business is currently valued at $7.5 billion with shares trading around $7.75. The company does operate with a sizable net debt position of some $5.6 billion. Fortunately for investors only $400 million in debt is due before or in 2018. The big debt load matures in 2020 when little over $3 billion in debt is maturing, giving the company still plenty of time to refinance.

Over the past year, Rite Aid managed to minimally grow revenues again to $25.5 billion. On these revenues, Rite Aid posted net earnings of around 1% on those sales with earnings coming in at $249 million. This values equity in the business at just 0.3 times annual revenues and 30 times GAAP earnings.

Given the high leverage and suboptimal profitability, Rite Aid does not pay a dividend currently.

Takeaway For Investors

So far the latest disappointment seems to be just a little bump on the road. Shares dropped from $8.50 to levels below $7.50 following the news but quickly gained back some ground.

Even at current levels, shares have gained more than 50% so far in 2014. Note that shares traded at levels of around $3 just a year ago. The company's strategy to transform from a conventional pharmacy into a neighborhood wellness and health center has paid off already. Combined with unprofitable store closures, the loyalty cards which improves repeated purchases and a better external environment, and Rite Aid has been able to show growth again.

Investors have picked upon these improvements and find the latest warning a good reason to take some cash off the table as the current share price reflects more future improvements. Competitors CVS Caremark (CVS) and Walgreen (WAG) have enjoyed the benefits of the strong general stock market momentum and for pharmacies as well. Their share prices have risen sharply as well over the past year.

Walgreen already trades at 1.0 times earnings versus just an 0.3 times multiple for Rite Aid, while CVS trades at much higher multiples as well. The reason of course is the lower leverage of those firms and greater operating margins, key areas for Rite Aid to improve upon in the coming years.

I believe the momentum last year and this year is greatly deserved as sales have started to increase again while leverage is under control and slowly declining. I am optimistic about the stock, although I would like to enter a position at levels with a greater margin of safety. Preferably I would like to pick up shares somewhere in the $6.50-$7.00 range. Strong momentum so far this year can always reverse, making me not a desperate buyer at current levels.

Source: Rite Aid - Strong Momentum Leaves Shares Vulnerable For Hiccups On The Recovery Path