Why Rite Aid got Hammered on Earnings!

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Last Thursday, Rite Aid reported earnings that surpassed analyst expectations for its most recent quarter, but issued full-year guidance that left Mr. Market feeling uneasy. As a result of the news, shares of the world's third-largest drugstore chain fell 10.24% to close at $5.17. Although the company's stock has outperformed every market index and competitors like CVS Caremark and Walgreen year-to-date, investors are likely beginning to question whether Rite Aid shares have gone up too fast and whether lower growth expectations are a sign to sell.

Earnings were in line with estimates but nothing special
For the quarter, revenue for Rite Aid came in at $6.36 billion. This represented a 1.9% gain from the $6.24 billion the company reported for the same period a year ago and it edged past the $6.32 billion that Mr. Market expected. Despite shutting down nine locations, the company saw its revenue increase due to a 2.3% jump in comparable-store sales. This was driven by a 3.5% increase in pharmacy sales but it was negatively affected by a 0.2% decline in front-end sales.

On an earnings per share basis, the company fell right in-line with what analysts expected. During the quarter, Rite Aid posted earnings per share of $0.04, well below the $0.07 it reported last year. Even though revenue increased for the quarter, the company's bottom line was affected by three things: cost of goods sold, increased share count, and the conversion of preferred stock.

The company's cost of goods sold rose from 71% of sales last year to 71.7% this year as management found it more costly to do business. Though this difference may not seem material, it meant a change in earnings per share (after taxes) of $0.12. Along with a 7.6% increase in the number of shares outstanding and a $25.6 million hit from the conversion of preferred stock, these factors really hit the company's bottom line.

This year's not looking too great
Over the past few years, Rite Aid's performance has steadily improved, with revenue staying steady and a $2.9 billion net loss in 2009 turning into a $118.1 million gain in 2013. On a per-share basis, the company reported a gain of $0.12 in 2013. Analysts had hoped the company would do far better this year with earnings coming in at $0.24.

However, management disappointed today by reporting that Rite Aid's earnings will likely fall, probably coming in at the wide range of $0.17-$0.23. Though such a miss wouldn't be catastrophic, investors are also likely scared about management's uncertain forecast that the next quarter could force results to swing one way or the other by up to $0.06 per share.

Rite Aid falls far short of its peers
There are two words that can describe how Rite Aid has fared compared to rivals like CVS and Walgreen; poorly but encouragingly. Over the past five years, the results of Rite Aid have been terrible, with revenue at a standstill and the aggregate net loss coming in at $4.2 billion. CVS and Walgreen, however, have performed considerably better.

Looking over the past five fiscal years, we see that CVS has been an engine for growth. The company saw its revenue grow by a whopping 40.8% during the period from $87.5 billion to $123.1 billion. This makes CVS, by far, the largest drugstore chain in the world. However, the company's growth has come at the cost of consistently low margins.

For instance, the net profit margin at CVS in recent years has been downright depressing, with a five-year average of 3.5%. Though this in itself isn't terrible, when you consider that the company's margin has declined almost every year and it has fallen from 3.7% five years ago to 3.1% now, then the situation begins to look very scary. What this implies is that management believes in growing the business even if that means forgoing profitability now.

Walgreen, on the other hand, has taken a very different approach. Over the past five years, revenue at the second-largest drugstore chain in the world rose 14% from $63.3 billion to $72.2 billion. By looking at this statistic and comparing it to CVS's results, you might conclude that Walgreen has been having difficulty surviving its larger peer's growth spurt. Unfortunately for shareholders of Walgreen, this appears to be the case.

Over the past five years, the net income at Walgreen has increased by 22.1%. The disparity between revenue growth and net income growth has led the company to report a slightly higher net profit margin. While the company's five-year average net profit margin has been 3.3%, it clocked in a margin of 3.4% for its most recent fiscal year.

Foolish takeaway
As we can see, the situation at Rite Aid is far from great but it's not terrible either. Rite Aid's results have been improving and this looks set to continue in the near future. However, compared to Walgreen and especially CVS, the company comes up short on both growth and profitability. While it is possible that management can continue this turnaround and make the company consistently profitable, an investment in Rite Aid should be reserved for those willing to handle the risk of a day like Thursday. For someone more interested in the preservation of capital, a look at CVS or Walgreen might be justified.

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The article Why Rite Aid got Hammered on Earnings! originally appeared on Fool.com.

Daniel Jones has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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