Management at the Rite Aid Corporation (RAD) is executing a turnaround strategy centered on increasing the profitability of the existing store base, which includes improving the product mix with generic and private label products. Nevertheless, management acquired the Brooks Eckerd chain prior to a convincing turnaround in profitability. Also, Wal-Mart's (WMT) initiative to enter the retail generic drug market should pressure the company's pharmacy margin.
Importantly, the company has a large debt burden. Management has twice lowered guidance on sales and earnings. The company's front-end sales declined in December, 2007 as the economic downturn has weakened consumer spending. Front-end sales are expected to remain weak. The company is highly leveraged, limiting cash flow availability and its ability to obtain additional financing. The debt burden from the Brooks Eckerd acquisition has increased interest expense by 91% in the last reported quarter.
The company receives a majority of its pharmaceutical products (approximately 90% of the dollar value of its prescription drugs) from a single supplier, McKesson Corporation (MCK). The contract runs through March 2009, and disruption with this relationship could adversely affect the company's performance. The expansion of stores by mass merchandisers is putting pressure on RAD s margins as the company faces competition from discount stores like Wal-Mart. In the last fiscal quarter, the digital photo business also negatively impacted profitability.
Most recently, the stock declined to $1.95 or 0.058 times expected post-merger annualized sales. However, if the turnaround plan and the integration of the Brooks Eckerd drug stores are successful, the upside is significant. Until there is strong evidence of sales improvement, the tentative target price is $2.50 based on a 0.075 price-to-sales ratio (based on expected post-merger annualized sales). Given management's lower guidance, the stock is rated a Sell.
Read the full analyst report on RAD.
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