We are maintaining our long-term 'Underperform' recommendation on Rite Aid Corporation (RAD) with a target price of $1.25 per share. Moreover, the company has a Zacks #3 Rank, implying a short-term 'Hold' rating on the stock.
Headquartered in Camp Hill, Pennsylvania, Rite Aid is the third largest retail drugstore in the U.S. based on revenues and number of stores. With 4,714 stores, the company operates in 31 states across the country and in the District of Columbia. The company's pharmacy operations accounted for 68% of fiscal 2011 revenue while the remaining 32% was generated by a wide assortment of "front-end" products. These products include over-the-counter (OTC) medications, health and beauty aids, personal care items, cosmetics, household items, beverages, convenience foods, greeting cards, seasonal merchandise, and numerous other convenience products, as well as photo processing.
However, pharmacy sales growth in the United States has slowed due to longer FDA approval process, drug safety concern, loss of individual health insurance resulting from unemployment and an increase in the use of non-brand drugs, which are less expensive but generate higher gross margin. Due to these factors, the company's same-store-sales are expected to remain weak. The company has reported loss for the last fourteen consecutive quarters.
Moreover, Rite Aid is a highly leveraged company (with approximately 135% debt-to-capitalization ratio), limiting cash flow availability and the company’s ability to obtain additional financing. The debt burden from the Brooks Eckerd acquisition has increased interest expense, which has been weighing upon the bottom line. This has put the company at a competitive disadvantage relative to its competitors with less indebtedness.
Furthermore, Rite Aid's generic drug sales are negatively affected by Wal-Mart Stores Inc.'s (WMT) strategy of entering the retail generic drug market. Due to Wal-Mart's broad array of manufacturers in India, Israel, and the U.S., the mass merchant can offer generic drugs at a discounted price compared with the average $10 generic drug co-pay.
In addition, due to intense competition in pharmaceutical business and an unmet demand for pharmacist in certain regions of the United States, it is becoming extremely tough for Rite Aid to retain its skilled workforce. The company is offering competitive compensation plans to retain and attract current and future pharmacist, which is exerting extra pressure on its performance.
Above all, the company competes with retail drugstore chains, independently owned drugstores, supermarkets, mass merchandisers, discount stores, dollar stores, and mail order pharmacies. Competitive pressure in the industry is unlikely to subside with continued consolidation, new store openings, and increased mandatory mail orders. The company's direct competitors are Walgreen Co. (WAG) and CVS Caremark Corporation (CVS).
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