Will Rite Aid's Recent Hire Make a Fundamental Splash?

In just a couple of short years, Rite Aid shares have soared from $1 to a high of more than $7. The gains have been in strong connection to its pharmacy business, including the introduction of new generics, and consequently higher margins. However, unlike its peers CVS and Walgreen , Rite Aid has yet to make a splash with the other half of its business, the retail segment, and last week's hire of David Abelman as VP of brand development and innovation doesn't seem to change this fact.

An area of dire need
To understand the strength and weakness of Rite Aid's business you need not look further than the company's most recent sales data for March. In the month, Rite Aid posted a 0.7% increase in same-store sales. This was viewed as a clear positive, especially considering Rite Aid saw revenue losses during the majority of its return to profitability in the last two years. It hasn't been until recently that Rite Aid has begun to show some sales strength, and if sustained, it could catapult the stock higher.

Granted, with higher same-store sales, it is important for investors to realize what is driving the growth. In March, the company's pharmacy same-store sales increased 3.5%. Meanwhile, its front-end sales declined 0.5%, which has become the norm with this company.

In comparison, both Walgreen and CVS have seen modest growth in the front-end of their stores. While this growth has been nowhere near as impressive as pharmacy, it is this additional growth that keeps both companies fundamentally superior. Essentially, CVS and Walgreen sell products that consumers want, therefore consumers naturally purchase their goods and prescriptions there; Rite Aid has lagged in this area.

As a result, CVS and Walgreen naturally have better year-over-year growth and higher margins, as front-end merchandise has historically produced higher margins than drugs. This can be seen in the table below:

CompanyProfit Margin2013 Revenue Growth2014 Growth Outlook
Rite Aid1.25%0%1.1% 
CVS3.62%3% 4.9% 

Clearly, if Rite Aid could bolster its front-end sales, it could possibly perform at near the levels of its peers. Yet, because Rite Aid's margins are lower, it has lacked growth in the past, and is expected to grow slower in 2014 versus its peers; it also has a lower multiple.

For example, Rite Aid trades at just 0.22 times sales versus 0.84 and 0.69 for Walgreen and CVS, respectively. Hence, if Rite Aid can close the gap, large gains could still be seen.

What's Rite Aid doing about it?
For the last few years, Rite Aid has undergone a restructuring process, closing, relocating, and opening new stores. But what Rite Aid needs in order to drive front-end sales growth is product innovation and new exciting brands. Thus, they hired David Abelman.

With that said, I think Rite Aid really missed a golden opportunity with this hire. Here's what Rite Aid had to say about Abelman in its PR:

Abelman was the CEO and co-founder of Self-Health Nation, a health and wellness omni-channel start-up focused on providing nutritional advice and solutions. Prior to that position, he was executive vice president and chief merchandising and marketing officer for A.C. Moore Arts & Crafts, He has also held senior-level marketing and merchandising positions with Michaels Stores, Office Depot, and Daymon Worldwide.

I'm a little discouraged about the lack of information about his recent venture, Self-Health Nation. Furthermore, A.C. Moore Arts & Crafts seems to be a store of little relevance to Rite Aid, as is the case with Office Depot and Michaels Stores, two companies not many would identify as thriving in the retail industry.

With that said, Abelman may be great, and may completely redesign the front end of Rite Aid, thus allowing it to thrive. However, given the fact that front end is a major point of weakness, and combined with Rite Aid's return to profitability, the company has the need to turn this part of its business around. Only time will tell whether Mr. Abelman will succeed.

Final thoughts
Rite Aid's stock has fallen double digits since its multi-year highs last month, and the company is set to report earnings on April 10. Therefore, its valuation discount relative to its peers, combined with continued margin improvements might allow for nice post-earnings gains.

Hence, a hit or miss with the VP of brand development and innovation is not something that will affect Rite Aid today, but long term, Rite Aid must capitalize on its front-end sales to be equal to its larger peers. Thus, this is a five-year hire, one where we'll look back, and if Rite Aid stores are thriving with new designs and more efficient technology, then we'll say Abelman was a great hire. However, if front-end sales remain flat, and Rite Aid is simply a margin improvement story, it'll also be a reflection of the hire.

Nonetheless, Rite Aid is not an expensive stock and has traded higher for good reason. In fact, it might still trade considerably higher, but in order to reach Walgreen- or CVS-like status, the front end of Rite Aid must be a significant part of its story.

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The article Will Rite Aid's Recent Hire Make a Fundamental Splash? originally appeared on Fool.com.

Brian Nichols owns shares of Rite Aid. The Motley Fool recommends CVS Caremark. 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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