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A New CEO is One Reason Why Rite Aid’s Long-Term Prospects are Improving

Chris Lau

Unlike Walgreens (NYSE:WBA) or CVS Health (NYSE:CVS), Rite Aid (NYSE:RAD) is on a permanent downtrend. The company hired a new CEO last month but that did not do much to restore confidence. It will take more efforts to turnaround the company, which would then help lift the RAD stock price.

A New CEO is One Reason Why Rite Aid's Long-Term Prospects are Improving

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Last month, Rite Aid appointed Heyward Donigan as its next CEO. She has 30 years in experience and all aspects of the healthcare industry. She was previously the CEO of Sapphire Digital, a firm that matches healthcare providers for consumers. Overall, her experience in digital channels, building consumer engagement, and leading companies to record growth are all skills that Rite Aid needs.

Rite Aid Falling Behind Competition

CVS shares held the $53 bottom and traded recently at $64. The stock rebounded because its second-quarter 2019 results exceeded the high end of its guidance range. CVS earned $1.89, 17 cents higher than its range, helped by its Retail/LTC and Pharmacy Services division. Similarly, Walgreens reported an EPS of $1.47 (non-GAAP) after revenue grew 0.8% to $34.59 billion. WBA stock also pays a dividend that yields 3.3%.

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Rite Aid reported Q1 results that lagged estimates. It lost 14 cents a share, compared to a two-cent profit the year before. Revenue slipped slightly to $5.37 billion. If Rite Aid did not have a $58 million interest expense and a $43.5 million restructuring-related charge, it could have earned a small profit.

Headwinds Holding Back RAD Stock

Rite Aid’s poor Q1 performance is due to a many factors. Gross profits fell primarily due to reimbursement rate pressure. It was unable to offset the drop with generic drug purchasing efficiencies and increasing volumes or prescription fills at stores.

The new CEO will need to firm up the management team to deliver on higher comparable same-store sales. Prescription volumes need to increase every sequential quarter. If this happens, the stock could start attracting buyers. For now, the $421 million market cap reflects the high uncertainties ahead in the business. Investors are unwilling to bid the stock higher until the company stops reporting poor operational performance.

Fixing the Business

As hard as it is to believe, Rite Aid may potentially report improving EBITDA. As it implements its cost-savings program and finishes its generic bidding activity, it will benefit from lower operating costs. Its EnvisionRxOptions faced margin compression in the quarter.  But this will be offset by stronger growth in Medicare Part D revenue. The current 2020 commercial selling season should give revenue a lift.

Seasonally speaking, higher immunization activity should help bring in more customers to stores. In the last quarter, immunizations doubled, beating its record number from last year.

Gross margins for Rite Aid’s retail reimbursement models are poor. So, the company’s new CEO needs to find additional ways to create value. And while Medicare Part D is an opportunity, it still needs to drive value for payor partners and itself.

Determining Valuation of RAD Stock

Analysts gave up on RAD stock. Most recently, a Deutsche Bank analyst called RAD stock a sell and set a $5 price target. This implies the stock has a downside of ~35% (per TipRanks). Similarly, investors who build a DCF 10-year terminal growth value model could make a few positive assumptions. If Rite Aid can grow revenue by 2% annually in the next decade, then the RAD stock price will trade in the double-digits (per finbox.io).

It is too early to guess how revenue changes in the next few years. Investors should wait for Rite Aid to first report growth in the next few quarters. If that happens, assuming single-digit sales growth annually will just be a starting point.

Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.

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