Rite Aid: One For The Books

| About: Rite Aid (RAD)
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Rite Aid quietly reported a quarter that missed expectations, but showed strong growth that will benefit Walgreens Boots when the merger closes.

I discuss the key metrics and performance of the company.

If Walgreens can watch this one key item post merger, it will be a very profitable move.

When I initiated coverage on Walgreens Boots Alliance (NASDAQ:WBA), I spoke about its success as a company. I also went on to discuss the Rite Aid (NYSE:RAD) acquisition. The truth is that we simply do not know how accretive the deal will be. While the Rite Aid acquisition was approved by shareholders, there is no real guidance on the impact of the buyout. Some have claimed the deal is dead. One reality is that share prices have been on the decline, which could be opportunity. If the deal goes through, which is on track for the second half of the year, my inclination is that like any other major merger, at first, the deal will be costly as the processes are integrated, stores are closed, employees moved, etc. Then, say a year or so later, things will be accretive, especially if WBA can cut the selling and administrative expenses. We will see. But, of course, Rite-Aid's operations need to be earnings/cash flow positive to be accretive. So, on that note, I want to discuss the just reported results out of Rite Aid.

Well, in fiscal Q1 2017, the company saw revenues of $8.2 billion, which missed estimates by $80 million. However, these were up 23% year over year. Now, in addition to the sales miss, there was a miss on earnings by $0.04. Net income came in at a loss of $4.6 million, or less than a penny per diluted share. On an adjusted basis, adjusted net income was $14.5 million, or $0.01 per share, while adjusted EBITDA was $286 million, or 3.5% of revenues. These headline numbers were a bit shaky, though things were much better year over year. But let's dig a little deeper.

Even with a pending merger, I continue to think the market inappropriately discounts sales growth. Revenues for the quarter were, of course, as I said, $8.2 billion, 23% higher than the revenues of $6.6 billion in the prior year's first quarter. Now some of this growth was from the purchase of EnvisionRX, but there were organic sales growth as well. So, let's look at the key metrics regarding sales.

Retail Pharmacy Segment revenues were $6.7 billion and increased 0.4% primarily as a result of a slight increase in same-store sales. Pharmacy Services Segment revenues were $1.6 billion. Same-store sales increased 0.4% year over year, consisting of a 0.1% increase in pharmacy sales and a 1.2% increase in front-end sales. Pharmacy sales included an approximate 198 basis point negative impact from new generic introductions. The number of prescriptions filled in same stores increased 0.6% over the prior-year period. Prescription sales accounted for 68.9% of total drugstore sales.

One critical item to recall is the effective management here. Despite the pending merger with Walgreens, the company continues to effectively manage its properties. In the quarter, the company relocated four stores, opened four new stores, and remodeled 79 stores, bringing the total number of wellness stores chain-wide to 2,126. The company also closed six stores, resulting in a total store count of 4,560 to start Q2. There are fewer stores now than what the company had two years ago, yet sales are much higher.

Now that Rite Aid finally completed its acquisition of EnvisionRx, sales are up nicely. It is interesting now that Rite Aid will merge with Walgreens Boots, but the key sticking point is whether or not the deal is accretive. It will be, provided the WBA cuts the expenses seen at Rite Aid. Given the results posted by Rite Aid, it is tough to say it will not be. Integrating the operations of a company the size of Rite Aid will be costly, so it is likely the first few quarters will be weighed by such expenses post-merger. That said, I maintain that Walgreens Boots made a smart move to scoop up Rite Aid as the company has been undergoing a transformation into a retail healthcare company. Rite Aid had been expanding beyond simply offering up medications and having a small retail front. I will add, that given the way Rite Aid's shares have traded lower, you could buy here and make a return when the buyout happens. It is something to consider.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles, which are time sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.