A lot has been going on with drugstore chain retailer Rite Aid Corporation (RAD - Free Report) , which has lost a whopping 80% this year, much wider than the industry’s decline of 12.5%. In fact, the stock has plunged nearly 21% over the past week, on speculations of Amazon.com Inc.’s (AMZN - Free Report) entry in the drugstore business.
After Amazon’s takeover of Whole Foods Market — a move that has kept grocery retailers on their toes — it looks like the online giant is now eyeing the drugstore industry. Though the news hasn’t been confirmed by Amazon, various media reports suggest that the e-commerce king is undertaking several steps to enter the prescription drug distribution space. Per the reports, Amazon is in talks with pharmacy benefit managers and various talented personnel to analyze the drugstore trends to foray into the market.
However, Amazon’s expansion strategy is just one of the reasons behind Rite Aid’s debacle. Let’s take a look at the other reasons for which this Zacks Rank #4 (Sell) stock has lost ground.
Merger Fallout With Walgreens
Rite Aid suffered a huge setback in June, when its merger with Walgreens Boots Alliance Inc. (WBA - Free Report) was terminated for failing to get the Federal Trade Commission’s (FTC) nod after two years of investigation. Thereafter, Walgreens agreed upon a fresh bargain to buy 2,186 Rite Aid stores, associated distribution assets and inventory, for $5.175 billion as well as termination charges of $325 million. However, this contract was also amended recently, to Walgreens agreeing to buy 1,932 Rite Aid stores, three distribution centers and related inventory in an all-cash deal. The former will now pay $4.375 billion for the deal. While this proposal finally won the FTC’s clearance last month, the string of all these events weighed upon investors’ sentiment.
Unfavorable Reimbursement Rates Dent Margins
Rite Aid has been battling unfavorable reimbursement rates for a while now. Evidently, lower pharmacy reimbursement rates dented the company’s Retail Pharmacy gross profit, which in turn hurt Rite Aid’s adjusted EBITDA in the first two quarters of fiscal 2018. Well, Rite Aid’s adjusted EBITDA margin contracted 100 and 110 bps in the first and second quarters of fiscal 2018, respectively. Nevertheless, termination charges of $325 million received from Walgreens partly cushioned Rite Aid’s operating results in the second quarter. However, management expects reimbursement rates to continue to pressurize pharmacy margins in the second half of the fiscal.
Unimpressive Surprise History, Dismal Q2 Performance
Rite Aid’s earnings surprise history is not very impressive. The company has underperformed the Zacks Consensus Estimate by an average of 20.8% in the trailing four quarters, including two quarters of negative earnings surprise. Though the company’s bottom-line matched the Zacks consensus mark in the second quarter of fiscal 2017, the company reported a loss of 1 cent as against the year-ago period earnings of 3 cents per share. Additionally, the top line remained soft, with same store sales declining on account of lower pharmacy and front-end sales. Apart from these factors, Rite Aid’s second-quarter debacle could be attributable to the impact of the merger ditch as well as the reduced reimbursement rates, as discussed above.
Any Positive Signals Ahead?
While the final pact with Walgreens will reduce Rite Aid’s core business, it is likely to lower Rite Aid’s debt position and improve its financial leverage and balance sheet. Management stated that it intends to use the funds from this deal to repay roughly $270 million worth of net liabilities associated with the divested assets; nearly $100 million of restructuring expenses and transaction fees and $85 million as income tax. Moreover, Rite Aid will continue to operate its pharmacy benefit manager — EnvisionRX, RediClinic and Health Dialog.
Thus, the latest contract should make Rite Aid a smaller, but stronger firm with lesser exposure to the pressures of unfavorable pharmacy reimbursement rates. However, management chose not to provide any guidance until it gets any clarity on the timing of its planned store divestitures. So for now, we prefer to remain on the sidelines.
Still Want Exposure in the Drugstore Segment?
Investors can count on Diplomat Pharmacy, Inc. (DPLO - Free Report) , which has delivered back-to-back positive earnings surprises in the past two quarters, and carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here
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