Rite Aid's Move Higher May Be Just The Beginning

| About: Rite Aid (RAD)
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Summary

Shares of Rite Aid soared after the business reported revenue and earnings that topped expectations for the third quarter of its 2013 fiscal year.

This, combined with the company's performance in recent years, is evidence that its turnaround is still progressing but that it still has a little ways to go.

Moving forward, investors should be optimistic, but should be cognizant of its share price, which isn't terribly expensive but isn't extremely cheap either.

Shares of Rite Aid (NYSE:RAD) rose nearly 12% on Dec. 18 after the company reported revenue and earnings for the third quarter of its 2015 fiscal year. On top of seeing strong sales growth, the business enjoyed earnings that easily topped expectations. After posting such strong performance, some investors might think that now's the time to take their cash and get out, but is it possible that the company could experience even more upside in the months and years to come?

Rite Aid's results were strong

For the quarter, Rite Aid reported revenue of $6.69 billion. This represents a 5% increase over the $6.36 billion management reported the same quarter last year and was slightly higher than the $6.65 billion analysts anticipated. Based on the company's most recent press release, this rise in revenue was driven largely by the business's comparable store sales, which soared around 5.4%. Given these stronger-than-expected results, management raised its forecast for fiscal 2015, with revenue expected to come in between $26.25 billion and $26.40 billion, around 3% above the $25.53 billion seen during fiscal 2014.

Earnings Overview
  Last Year's Forecasted

Actual

Revenue (billions) $6.36 $6.65 $6.69
Earnings per Share $0.04 $0.05 $0.10

From a profit standpoint, the picture was even better. For the quarter, the drugstore chain saw its earnings per share hit $0.10. This represents a 150% increase over the $0.04 seen the same quarter a year earlier and was double the $0.05 Mr. Market was hoping to see. In addition to benefiting from strong sales growth, Rite Aid's bottom line improved due to a decline in its cost of goods sold from 71.7% of sales to 71.3% and in its interest expense from 1.6% of sales to 1.5%.

Things have been getting better, but are shares still attractive?

The past few years have been anything but easy for Rite Aid. Between 2010 and 2014, for instance, the business saw its revenue dip around 0.6% from $26.67 billion to $25.53 billion as a modest increase in comparable store sales has been mostly offset by a decline in the number of locations in operation. The reason behind this decline in store count during this time period is that management has been trying to save the company as harsh economic times during the past financial crisis, increased competition, and the fallout from a poor expansion strategy left the drugstore chain losing money year-over-year.

RAD Revenue (Annual) Chart

RAD Revenue (Annual) data by YCharts

Thanks to management's decision to cut out underperforming locations and to place a greater emphasis on growing comparable store sales and margins, Rite Aid's net loss of $506.68 million in 2010 turned into a gain of $249.41 million by the end of its 2014 fiscal year. During its 2015 fiscal year, results are expected to be even better, with net income rising to between $315 million and $370 million. As the company (and the industry as a whole) continues to gravitate more toward generic drugs, which offer lower sales but higher profit margins, it's not unreasonable to expect this trend to continue.

How Expensive Are Shares?
  Analysts' P/E Management's Low P/E Management's High P/E
Rite Aid 21.9 21.9 18.3

Looking at this data, it appears as though investors might have an attractive prospect, but how much are they paying for this margin improvement and new-found growth? Well, using analysts' estimates for the company's 2015 fiscal year for earnings per share of $0.31 yields a P/E ratio of 21.9 at the moment. While this is pretty high for a turnaround that's not entirely out of the woods (its sales growth is far slower than the growth exhibited by its peers so its turnaround can't be deemed a success yet), the $0.37 maximum earnings per share forecasted by management places a more reasonable multiple of 18.3 on the business.

Takeaway

Right now, investors seem to have a lot to look forward to when it comes to Rite Aid. On top of seeing stronger-than-expected revenue and earnings growth, the drugstore chain's past few years show that things are turning around nicely. Assuming management doesn't make any material mistakes moving forward, it appears that this trend will likely continue and sales and profits will grow accordingly. What's more, while lower-end estimates place a relatively pricey valuation on the business, management's more optimistic expectations show a company whose shares aren't cheap but aren't unreasonably expensive either.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.