Rite Aid Corporation (RAD): This Company Turns a Profit, Why I Am Not Impressed

Encroaching competitors
Longer-term, I think Rite Aid will have trouble remaining profitable in the face of strong competition from its two larger rivals. Rite Aid has benefited from trends such as the growth of generics and the aging of the U.S. population, which are helping the whole industry. For Rite Aid, improving industry conditions have allowed the company to reduce its leverage while remodeling a few hundred stores each year. By contrast, Walgreen and CVS Caremark Corporation (NYSE:CVS) have more resources at their disposal, and so strong profitability has encouraged expansion. In their most recent fiscal years, CVS added 131 stores, and Walgreen added 175 stores.

Convenience is paramount in the drugstore business, and as Walgreen and CVS add locations — thereby moving closer to customers — they will gain market share. Expansion will also increase economies of scale for both chains. Rite Aid does not have the capital resources to expand, and has actually been reducing its store count. In the short term, closing underperforming stores should boost Rite Aid’s profitability, but in the longer term, this will increase the competitive advantages of Walgreen and CVS.

Buyer beware
Rite Aid’s high leverage gives the stock substantial upside if management is able to enact a sustainable turnaround. However, I am not optimistic about Rite Aid’s chances in an industry where its two main competitors are significantly larger and expanding, while Rite Aid is slowly shrinking. As Walgreen and CVS move closer to customers through store expansion, Rite Aid will struggle to maintain its market share. As a result, the company’s return to profitability could prove short-lived.

The article Rite Aid Turns a Profit: Why I’m Not Impressed originally appeared on Fool.com.

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

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