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RAD AT A GLANCE

P/E ► -0.558   EV/EBITDA ► -6.34   ROA ► -21.4% VERY LOW ROE ► -2110.8% VERY LOW Debt to Equity ► -6.82   Current Ratio ► 1.98 AVG Interest Coverage Ratio ► -3.71 VERY LOW

 

 

 

 

 

 

Rite Aid (NYSE: RAD) is the third-largest drugstore chain in the United States, with over 5,100 stores. The company makes most of its money from the sale of prescription drugs, but it also sells non-medical items such as cosmetics and greeting cards. The company should benefit from the tailwind of an aging U.S. population; people over 54 use drugs at much higher rates than their younger counterparts. Rite Aid, however, faces increasing competition from non-traditional drug retailers. Most notable among these is Wal-Mart, which recently began selling over 360 generic drugs for only $4 per subscription. This is significantly less than RAD's prices and may put pressure on the company's drug margins. It also has implications for the company's higher margin front-store (beauty products, snacks, etc.) sales, which are heavily dependent on RAD's ability to cross-sell customers who come in for prescriptions.

Company Overview

As a drugstore retailer, the majority of Rite Aid’s business is in prescription drugs, with the remaining coming from front-end products.

Prescription drugs: RAD is the third largest U.S. chain drugstore, and the company depends on its retail pharmacies to bring in a large percentage of its revenue. Approximately 43% of its stores also had a drive-thru pharmacy. In 2009, prescription drugs represented 66.9% of revenue. ^[1]

Front end products: include over-the-counter medications, cosmetics, greeting cards, photo processing, and other products. RAD tries to differentiate its front end products by offering private brands and through their strategic alliance with GNC, which makes vitamin and mineral supplements. In 2009, front-end products represented 32.6% of the company's revenue.^[1]

The remaining 0.5% of revenue comes from miscellaneous sources such as business-to-business transactions.

Business Growth

In 2008, revenue grew 8.1% to $26.3 billion, with a 2.2% increase in pharmacy sales and 0.1% increase in front-end sales. However, Rite Aid’s net loss increased even further from $1.1 billion to $2.9 billion. A major contributor to this loss was a $1.8 billion write-off of goodwill required because the market value of RAD stock rose above the carrying value of the company’s net assets.

Rite Aid also incurred store closing charges of $293.7 million, an increase of 240% over the prior year, due to a higher rate of store closings and impairments relative to previous years. Many of these closures were a result of eliminating stores that Rite Aid deemed to be overlapping with stores acquired in Rite-Aid's $2.3 billion acquisition of Brooks Eckerd in 2007.^[2] While Rite Aid ended Q4 of fiscal 2009 with 4,901 stores, by Q4 of fiscal 2009 it had already closed a net of 100 stores.

Quarterly Business Financials

Rite Aid reported a decline in revenue of 26% for the fiscal year (ending February 28th, 2009), with revenues falling from $9 billion to $6.7 billion. Q4 of fiscal 2009 also saw a decrease in revenue from $6.8 billion in Q3 to $6.7. Losses were driven mainly by non-cash charges. Despite these losses, Rite Aid's same-store sales (excluding the acquired Brooks Eckerd stores) increased by 0.8% through the fourth quarter and the fiscal year, and the company generated $324.8 million in positive cash flow from operations in Q4. By the end of this quarter, Rite Aid opened 6 stores, relocated 10 stores, and closed 19 stores, arriving at a total of 4,901 stores by the end of the fourth quarter.^[3]

In Q1 of fiscal 2010 (ended May 30, 2009), Rite-Aid reported $6.5 billion in revenues, a 1.2 % decline over the previous year. The decline was primarily due to store closings. Rite Aid had 4,825 stores in operation at the end of the first quarter.

In Q2 of fiscal 2010, Rite-Aid reported revenues of $6.3 billion and a net loss of $116.0 million. Over the same quarter in the previous year, revenues declined 2.7%, while the net loss decreased by 47.7%.^[4] However, based on lower expectations in the continued weak U.S economy, Rite-Aid lowered its 2010 expected earnings and other fiscal guidance. Rite Aid had 4,812 stores in operation at the end of the second quarter, a decline of 13 over the previous quarter. ^[4]

In Q3 of fiscal 2010 (ended November 28, 2009), Rite Aid reported revenues of $6.4 billion, a decline of 1.8% over the previous year’s Q3, and a net loss of $83.9 million, an improvement over the previous year’s Q3 net loss of $243.1 million. The decline in revenues was attributed to store closings and a decline in front-end same store sales. In the third quarter, the company opened 3 stores but closed another 14. Stores in operation at the end of the third quarter totaled 4,801. ^[5] Rite Aid forecast declining front end sales for the remainder of fiscal 2010 due reduced consumer spending on non-essential items and more aggressive bargain shopping. At the same time, Rite Aid predicted lower pharmacy margins due to reimbursement rate pressures, fewer new generics, and the impact of a recently implemented AWP cost adjustment in its Medicaid business. ^[6]

Acquisition of Brooks/Eckard

On June 4, 2007, RAD acquired Jean Contu USA, which owns the Brooks Pharmacy and Eckard Pharmacy chains, for $2.4B. The acquisition increases Rite Aid’s presence on the East Coast and its store count by 1,854 stores, making the company’s number of total stores more comparable to competitors Walgreen’s and CVS. The additional size should benefit Rite Aid through greater economies of scale, an asset in the low-margin prescription drug market. However, the acquisition has added $2.2B in debt to finance the acquisition and additional costs of $500 million to remodel all Brooks Eckard locations over the next few years.^[7]

Indebtedness

With over $6B in debt, Rite Aid is on precarious ground. The company is vulnerable to increases in interest rates, as a portion of its debt is priced at adjustable rates. Higher interest rates can also make it more expensive to refinance existing debt. Rite Aid's current ratio of assets to liabilities, which represents its state of liquidity, is less than one (0.87), a low number relative to its competitors.

Trends and Forces

Aging Population

An aging baby boomer segment, estimated at 76 million people, continues to fuel an increase in demand for prescription drug sales. The American Association of Retired Persons (AARP), reports that while people in the 25-54 age group fill between 5 and 12 prescriptions each year, people over the age of 55 fill between 19 and 24 prescriptions. As this generation of boomers gets older, RAD's prescription drug sales could increase.

Generic Prescription Drugs

The retail drugstore industry will benefit from accelerated generic prescription drug sales, as a significant number of branded drugs will come off patent between 2006-2009. RAD believes a significant number of new generics will be introduced in the next couple of years. The gross profit from a generic drug prescription is greater than the gross profit from a brand drug prescription because of lower wholesale prices. However, while RAD's margins may increase, revenue growth may be slower because generic drugs sell for a lower price.

Reliance on Medicare and Medicaid

The retail drugstore industry relies significantly on third party payors such as Medicare and Medicaid, which cover over 80 million Americans. In 2007, RAD generated nearly 20% of its revenue from these two sources.^[8] These organizations periodically change the beneficiary eligibility requirements and drug reimbursement rates. When third-party payors reduce the number of participants or reduce their reimbursement rates, RAD's sales and margins could be reduced.

• Medicare Part D: the introduction of Medicare Part D in January of 2006 has contributed to an increase in prescription drug utilization as the program provides coverage to an extra 5-8 million people who did not previously have creditable coverage. However, many of these new customers come with lower reimbursement rates than what they would have paid RAD without coverage from Medicare. RAD has suffered a slight decline in margins as millions of cash payors continue to enroll in Medicare Part D. ^[9]

• Medicaid: on January 1, 2007, the U.S. government issued Medicaid cuts under the Deficit Reduction Act (DRA) of 2005, calling for reduced reimbursement rates for prescriptions to pharmacies. This could lower RAD's pharmacy sales.

Increasing Competition from Supermarkets

Recently, many competitors outside of the traditional drugstore retailers have made aggressive moves into the prescription drug market. Most notable is Wal-Mart, which recently began selling over 360 generic drugs for only $4, significantly less than RAD's prices. Since then, Wal-Mart has expanded its $4 generic drug distribution to 16 states and nearly 360 drugs. ^[10] Given that Wal-Mart has over 4,000 stores in the US and a presence in nearly every major metropolitan market, it could have a major impact on the pricing and margins of generic drugs. This may ignite a price war and put compounded pressure on the RAD's drug margins and lower its profits.

Market Share

Walgreen Company (WAG) is industry's strongest company across the country, with the top spot in 44 of the 100 largest drug store markets, including the No. 1 share in 5 of the 10 largest areas and No. 2 share in another 23 and No. 3 in 14.

CVS (CVS) is either first or second in every one of the top 10 markets and No. 1 in the two largest drug store markets --the New York and Los Angeles metropolitan areas. Overall, it has the No. 1 share in 30 markets and No. 2 share in 27 and No. 3 in 8.

Rite Aid (RAD) is the No. 1 chain in 16 markets, with one ranking in the Top 10, via the acquisition of Eckerd stores in Philadelphia.

Competition

• CVS/Caremark (CVS) generated $86 billion in sales for 2008 and is the largest retail pharmacy in the U.S.

• Walgreen Company (WAG) generated $59 billion in sales for 2008 and is the second largest drugstore retailer after CVS/Caremark.

• Wal-Mart (WMT), which, with $401 billion in 2008 sales, is one of the largest corporations in the world, has been increasing its presence in the retail pharmacy industry.

• MedcoHealth Solutions (MHS) generated $51 billion in sales for 2008, and is one of the largest pharmacy benefit management companies in the industry.

In addition to other drugstore retailers, Rite Aid also competes with supermarkets and convenience stores which fill prescriptions.

Reference

1. ↑ ^{1.0 1.1} 2009 Rite-Aid Annual Report, Page 68 (PDF 138)
2. ↑ 2009 Rite Aid 10-K Annual Report, p. 27
3. ↑ Rite Aid's Fourth Quarter and Annual Financial Reportings
4. ↑ ^{4.0 4.1} Rite-Aid 2009 2nd Quarter Summary
5. ↑ 2009 3rd Quarter Summary
6. ↑ 3rd Quarter Summary
7. ↑ RAD 10Q 2007, Pg 9
8. ↑ RAD 2007 10K, Pg 18
9. ↑ RAD 2007 10K, Pg 35
10. ↑ Wal-Mart Pharmacy