In a series of articles over the past two months, I have argued that the apparent turnaround occurring at Rite Aid Corporation (NYSE:RAD) over the past year or so has probably been a fluke, and that the company may be about to head downhill again. If you missed the earlier articles, the main argument is simple: In 2012, Rite Aid Corporation (NYSE:RAD) benefited from several one-time items that boosted profits. The two biggest factors helping Rite Aid were: 1) a dispute between Walgreen Company (NYSE:WAG) and pharmacy benefits manager Express Scripts Holding Company (NASDAQ:ESRX), and 2) a wave of generic-drug introductions, which improved pharmacy gross margin.
Walgreen and Express Scripts eventually came to a compromise, and since September many of the customers who had switched to Rite Aid or CVS Caremark Corporation (NYSE:CVS) last year have been returning to Walgreen’s pharmacies. Rite Aid Corporation (NYSE:RAD)’s management estimated the benefit of this dispute at $70 million last year, representing more than half of the company’s total profit.
Furthermore, 2013 will feature a much slower pace of generic-drug introductions, while insurers continue cutting their reimbursement rates. These two factors could potentially reverse Rite Aid Corporation (NYSE:RAD)’s pharmacy gross margin gains. With some of last year’s unusual tailwinds thus likely to reverse in fiscal year 2014, one might expect shareholders to be cautious about Rite Aid’s prospects. Instead, shares have more than doubled in the last six months, reaching a new five-year high:
Recent sales data appear to confirm a slowdown in sales at Rite Aid, which will ultimately pressure the bottom line. Accordingly, I believe that Rite Aid shares have become overvalued during their recent run.
Sales data continues to disappoint
Last week, Rite Aid reported disappointing sales data for April. This bolsters the case that the company’s surprise profit in fiscal year 2013 did not reflect a sustained improvement in the business. Same-store sales decreased 4% last month, with front-end sales down 3.5% — partially due to the shift of Easter to March this year — and pharmacy same-store sales down 4.2%. Prescription count was down 0.2% year over year, confirming that some customers are taking their business back to Walgreen. In fact, Walgreen experienced a 9.7% increase in prescription count last month, or 6.3% accounting for a calendar-day shift compared to 2012. The divergence in pharmacy results between Rite Aid and Walgreen is very significant.
For the combined March-April period, Rite Aid Corporation (NYSE:RAD)’s same-store sales were down 3% due to the introduction of new generic drugs. Front-end same-store sales increased 0.1%, and prescription count also increased 0.1%. In other words, if we adjust for the timing of Easter and the effect of generic introductions, Rite Aid’s comparable-store sales have not turned negative yet. That said, sales gains have slowed to a crawl, and may not be sufficient to cover normal inflation in operating expenses.
A look at Rite Aid Corporation (NYSE:RAD)’s monthly sales data for 2012 and 2013 (year to date) shows a clear downward trend. To be fair, some of the deceleration in late 2012 was caused by a higher rate of new generic introductions. However, this effect has tapered off in the past several months, while the downtrend continues:
Rite Aid same-store sales
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