Rite Aid Corporation (RAD) May Be Headed Downhill Again: Walgreen Company (WAG), Express Scripts Holding Company (ESRX)

For much of 2012, troubled pharmacy chain Rite Aid Corporation (NYSE:RAD) seemed to be pulling itself up by its bootstraps. It benefited from a dispute between Walgreen Company (NYSE:WAG) and Express Scripts Holding Company (NASDAQ:ESRX) that forced many former Walgreens patrons to fill their prescriptions elsewhere. Furthermore, the company saw improved sales at stores that it remodeled to a new “wellness” format. In Q3, these sales drivers culminated in Rite Aid’s first quarterly profit since 2007.

However, Walgreen Company (NYSE:WAG) and Express Scripts Holding Company (NASDAQ:ESRX) finally settled their long-running dispute last summer, and Walgreens stores rejoined the Express Scripts Holding Company (NASDAQ:ESRX) network on Sept. 15. Moreover, at the same time the company rolled out its first loyalty program, called “Balance Rewards”, as part of a push to win customers back from Rite Aid and CVS Caremark Corporation (NYSE:CVS) . While it’s too early to be sure, it appears that Walgreen’s resurgence is squeezing Rite Aid again. Rite Aid has a heavy debt load of roughly $6 billion and is much smaller than Walgreen and CVS — two major competitive disadvantages. Rite Aid is therefore a very risky investment and should probably be avoided.

Rite Aid Corporation (NYSE:RAD)Sales momentum tapers off
Rite Aid Corporation (NYSE:RAD)’s strong Q3 earnings were the result of 1.1% same-store-sales growth in the front end (non-prescription sales) and a 3.6% increase in prescription count in comparable stores. (Overall, same-store sales decreased 1.5% because of the introduction of new lower-cost generic drugs.) However, performance was strongest early in the quarter, before Walgreen Company (NYSE:WAG) had a chance to win back Express Scripts Holding Company (NASDAQ:ESRX) customers.

Q4′s performance could have been much worse, if not for the bad U.S. flu season. Front-end sales decreased 1% in December while prescription count increased 4.4%, including a 170-basis-point gain from sales of flu shots and flu-related prescriptions. January was even stronger, with the front end up 4.2% (2.4% attributable to flu treatments), and prescription count up 5% (3.4% resulting from flu-related prescriptions). However, Rite Aid’s momentum dissipated with the end of flu season. With no flu-related tailwind in February, front-end sales dropped by 1.3% and prescription count increased by a meager 0.3 %.

Turnarounds are expensive
Rite Aid Corporation (NYSE:RAD) once again faces two stronger competitors in Walgreen Company (NYSE:WAG) and CVS. Convenience is a key competitive advantage in the drugstore industry, giving larger chains such as Walgreen and CVS an edge. I’m skeptical that Rite Aid will be able to successfully fend off this competition in light of its fading sales momentum and weak balance sheet. A case in point is the rollout of the “wellness” format stores. While these stores outperform the company average, Rite Aid Corporation (NYSE:RAD) has been remodeling stores at a rate of only 110 to 120 per quarter. At that rate, it will take roughly a decade to convert all stores to the new format. However, Rite Aid’s weak balance sheet and limited cash flow make it difficult for the company to invest more aggressively in its stores. Ultimately, Rite Aid’s weaknesses outweigh its strengths and make it a poor long-term investment candidate compared with Walgreen and CVS.

The article Rite Aid May Be Headed Downhill Again originally appeared on Fool.com.

Fool contributor Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool recommends Express Scripts and owns shares of Express Scripts.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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