Rite Aid (RAD)

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See all Bulls Reasons Bulls: Reasons To Buy Brooks/Eckerd Aquisition Increases Economies of Scale 100% agree Brooks/Eckerd Aquisition Increases Economies of Scale Adding more than 1,800 east coast stores via the acquisition of Brooks/Eckerd increases economies of scale in advertising, purchasing, and distribution. The acquisition was a risky move considering the amount of debt it incurred in an already poor economic environment, but if... read more View or Edit Reason 6 votes 100% agree See all Bears Reasons Bears: Reasons To Sell Walmart's $4 prescription program is expanding 100% agree Walmart's $4 prescription program is expanding Walmart's pharmacy is selling deeply discounted generics. This could attract customers away from Rite Aid. View or Edit Reason 1 votes 100% agree Send the authors a comment or suggestion Be the first to make a suggestion See All Suggestions

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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.

[edit] 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 the companies revenue. Approximately 43% of its stores also had a drive-thru pharmacy. In 2007, prescription drugs represented over 63% 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. ^[2]

RAD 2007 10K^[3]

In 2007, revenue grew 1.4% to $17.5B, with a 2.2% increase in pharmacy sales and 0.1% increase in front-end sales. However, operating income decreased further due to lower margins in front-end merchandise and higher selling, general and administrative (SGA) expenses. ^[4]. Specifically, the cost of goods and selling, general and administrative expenses increased between .5% and 2% faster than revenue. In 2006 , expenses associated with store closing also resulted in another $35MM in expenses.

RAD 2007 10K^[5]

[edit] 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.^[6]

[edit] 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 their debt is priced at adjustable rates. Higher interest rates can also make it more expensive to refinance existing debt.

[edit] Trends and Forces

[edit] Aging Population

An aging American segment, known as baby boomers, with an estimated size of 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.

[edit] 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. However, while RAD's margins may increase, revenue growth may be slower because generic drugs sell for a lower price.

[edit] Reliance on Medicare and Medicaid

The retail drugstore industry relies significantly on third party payors such as Medicare and Medicaid, which cover over 80M Americans. In 2007, RAD generated nearly 20% of its revenue from these two sources.^[7] These organizations periodically change the eligibility requirements to reduce the number of participants or reduce certain reimbursement rates of drugs. 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. ^[8]

• 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.

[edit] 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. ^[9] 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.

[edit] 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.

[edit] Competition

• Walgreen Company (WAG) ] generated $47B in sales for 2006, ranking it the largest drugstore retailer in the U.S.

• CVS/Caremark (CVS) generated $44B in sales for 2006 and is the second largest drugstore retailer after Walgreens.

• Longs Drug Stores (LDG) is a smaller competitor, with $5.1B in sales for 2006.

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

[edit] Reference

1. ↑ RAD 2007 10K, Pg 4
2. ↑ RAD 2007 10K, Pg 4
3. ↑ RAD 2007 10K, Pg 63
4. ↑ RAD 2007 10K, Pgs 30-34
5. ↑ RAD 2007 10K, Pg 60
6. ↑ RAD 10Q 2007, Pg 9
7. ↑ RAD 2007 10K, Pg 18
8. ↑ RAD 2007 10K, Pg 35
9. ↑ Wal-Mart Pharmacy
10. ↑ RAD 2006 10k, Pg 20
11. ↑ RAD 2006 10k, Pg 20
12. ↑ 2007 net income was inflated by a tax benefit of $1.2B
13. ↑ RAD 2006 10k, Pg 23
14. ↑ WAG 2006 10k, Pg 1
15. ↑ WAG 2006 10k, Pg 1
16. ↑ WAG 2006 10k, Exhibit 13
17. ↑ CVS 2006 10k, Pg 21
18. ↑ CVS 2006 10k, Pg 21
19. ↑ CVS 2006 10k, Pg 19