Rite Aid (RAD) Soars Too High Too Fast: Is This Justified?

Rite Aid CorporationRAD stock seems to have gained solid momentum following the recent agreement to sell 1,932 stores, three distribution centers and related inventory to Walgreens Boots Alliance Inc. WBA for $4.375 billion in cash. The company has been witnessing an uptrend in its share price since completing the pilot closing and the first transfer of 97 Rite Aid stores and related assets during third-quarter fiscal 2018.

The company is on track with the transferring stores and related assets to Walgreens in a phased manner, having transferred 357 stores for net proceeds of about $715 million so far. This has probably aided its stock performance. Shares of Rite Aid gained 29.1% in the last three months, outperforming the industry 's growth of 4%.

Though the recent stock gain may entice investors, we need to know more about the company's fundamentals before really investing in the stock. Deciding upon an investment only based on the stock movement can be futile many a times. We believe Rite Aid is one such stock, as the company has big challenges ahead and there is lot to be done before tasting real success. Clearly, the company's third-quarter fiscal 2018 results suggest that it is still struggling with operations, and a full turnaround is still away.

Dismal Sales Trends - A Major Concern

A look at the recently reported third-quarter fiscal 2018 results shows that Rite Aid is grappling with the top line. Though the company's break-even bottom-line results surpassed the Zacks Consensus Estimate in third-quarter fiscal 2018, sales lagged for the second straight quarter. Notably, Rite Aid has delivered negative sales surprise in four of the trailing six quarters.

Further, sales for the fiscal third-quarter dropped 5.6% year over year. This marked the company's third straight quarter of year-over-year sales decline. Notably, sales declined 4.9% and 4.4%, respectively, in the first and second quarters of fiscal 2018. Rite Aid's revenues continue to be hurt by soft comps as well as decline in revenues at key business segments - Retail Pharmacy and Pharmacy Services.

Rite Aid Corporation Revenue (Quarterly YoY Growth)

Rite Aid Corporation Revenue (Quarterly YoY Growth) | Rite Aid Corporation Quote

Retail Pharmacy segment, which engages in selling prescription drugs, health and beauty products, and personal care items, reported revenue declines of 4.9%, 3.4% and 3% in the first, second and third quarter of fiscal 2018, respectively. The segment revenues were persistently hurt by soft same store sales and unfavorable reimbursement rates. Notably, unfavorable reimbursement rates have been a challenge for the company's top-line for nearly two years now.

Meanwhile, revenues for the Pharmacy Services segment, which provides PBM (pharmacy benefit management) services and a range of pharmacy-related services, dropped 5.6%, 8.7% and 12.2%, for the first, second and third quarter of fiscal 2018, respectively. Revenues at the Pharmacy Services segment declined due to an election to take part in lesser Medicare Part D regions and a fall in commercial business.

Coming to comps, Rite Aid's comps dropped 2.5% in third-quarter, can be attributed to fall in pharmacy and front-end sales. Notably, the company's comps have declined for six straight quarters now, reporting declines of 3.9% and 3.4%, respectively, in the first and second quarters of fiscal 2018. Moreover, comps dipped 2.5%, 3.4% and 3% in the second, third and fourth quarter of fiscal 2017.

What is Rite Aid Doing to Drive Revenues?

Rite Aid's rescue to the biggest challenge of unfavorable reimbursement rates lies in the aforementioned sale of stores and assets to Walgreens. The company's smaller size after the sale of these assets is likely to reduce Rite Aid's exposure to the pressures of unfavorable pharmacy reimbursement rates. However, the real outcome will be evident only after all the stores are transferred to Walgreens.

Further, the company anticipates its Pharmacy Services segment to gain traction in coming days as it plans to promote the PBM business, which it manages through Envision Rx that was acquired in 2015. Notably, the company grew Envision Rx's Medicare Part D membership by more than 100,000 lives to 500,000 lives in the past year.

Going forward, the company expects Envision to drive growth across the board, as it targets increasing its customer base by 100,000 customers into fiscal 2019. Additionally, the company's Health Dialog and RediClinic businesses are likely to aid health and wellness scores, which should improve overall performance.

Health Dialog can aid in providing better health and wellness services to communities by facilitating partnership with customers to improve medication adherence and better compliance to drug therapies. Simultaneously, RediClinic is poised to provide high quality, convenient and affordable healthcare services in a retail setting, consequently improving store traffic.

Wrapping Up

Though the company's plans for the PBM business as well as its Health Dialog and RediClinic wings are impressive, we believe there is a lot of work to be done. We only focused on one side of the coin here, however, there are many more problems to the Rite Aid story apart from these sales issues. To sum up, the company has a heavy debt burden, which will only be partly addressed by the proceeds from the sale of stores to Walgreens. Further, the company is lagging on the margins front and has to significantly save on drug costs to stay in competition.

This makes it clear that the stock is not yet ready to reward investors with glorious returns, even though the share price has grown in leaps and bounds lately. Rightly, Rite Aid currently carries a Zacks Rank #4 (Sell).

Does the Retail Sector Entice You? Check These Stocks

Investors interested in the drugstore space should consider investing in Walgreens, which has grown 7.3% in three months and carries a Zacks Rank #2 (Buy). Further, it has a long-term growth rate of 10.4%.

For more exposure in the broader retail sector investors can count on Diplomat Pharmacy, Inc. DPLO with a Zacks Rank #1 (Strong Buy) and Shoe Carnival Inc. SCVL , carrying a Zacks Rank #2. You can see the complete list of today's Zacks #1 Rank stocks here .

Diplomat Pharmacy has advanced 21% in the past month. The stock has a long-term growth rate of 6.6%.

Shoe Carnival, with long-term earnings per share growth rate of 12%, has surged 24.7% in the last three months.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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