What happened on Thursday?
June 18, I wrote my very first cautionary Rite Aid Corporation (NYSE:RAD) article, appropriately titled “A Cautionary Approach to Rite Aid” In the piece, I presented my belief that Rite Aid was due for a small pullback, and that earnings could be the event to produce the loss.
I also disclosed owning 15,000 shares, and that I was selling 5,000 ahead of earnings; hoping to buyback at a cheaper price. Turns out, I was right, as the stock pulled-back more than 7% after earnings.
Following this post-earnings pullback, I now see two ways to approach the stock.
- Preparing For Speed Bumps
In my article, “A Cautionary Approach to Rite Aid” I explained that recently updated full-year net income guidance of $49-$189 million, leaves the company performing somewhat poorly in the second half of the year, relative to its start of the year.
For its most recent quarter (Thursday), the company posted a profit of $89.7 million. Thus, Rite Aid Corporation (NYSE:RAD)’s remaining three quarters could produce a combined loss of ($50 million) or a profit of $100 million. When you consider that Rite Aid has now produced three consecutive quarterly profits, the market may not be unforgiving to any future net losses.
According to Rite Aid Corporation (NYSE:RAD), fewer generic introductions will lead to a more difficult second half of the fiscal year. So far, the company’s incredible fundamental improvements have been mostly due to new generic drugs, as these drugs pay larger premiums to pharmacies.
But with fewer generics, it is possible that we see short-term weakness. Thus, with the company already trading higher by 200% in the last six months, you might want to wait and see how the company performs in future quarters before buying; or trim your position for the second half of the year.
- Go Long-Term!
Seeing as how Rite Aid Corporation (NYSE:RAD)’s most impressive quarters have already come and gone – at least for the short-term – it makes sense that some would want to sell their shares and seek value elsewhere. The only problem is that there really aren’t too many places in the market with greater value than Rite Aid.
The bottom line is that Rite Aid is now profitable. The six years of net loss that drove its stock from $6 to $1 is now a thing of the past; as the company has greatly improved operationally. Now, because it lost so much value from 2007 to late-2012, the stock is significantly cheaper than Walgreen Company (NYSE:WAG) or CVS Caremark Corporation (NYSE:CVS).
| Rite Aid | Walgreen | CVS | |
|---|---|---|---|
| Trailing P/E | 12.3 | 13.3 | 13.0 |
| Profit Margin | 0.47% | 2.91% | 3.3% |
| Price/Sales | 0.10 | 0.65 | 0.57 |
As you can see, Rite Aid is cheaper compared to both future earnings, and then definitely when compared to sales. This chart shows the level of value present in shares of Rite Aid Corporation (NYSE:RAD) – six times cheaper compared to sales – but it also has more room to fundamentally improve versus Walgreen Company (NYSE:WAG) and CVS Caremark Corporation (NYSE:CVS).
During each company’s last quarter, they all saw margin improvements due to new generic introductions. In the pharmacy business, this has been the greatest known catalyst, as generic drug companies pay pharmacies more to use generics versus name brand drugs.
During the most recent quarter, Walgreen Company (NYSE:WAG) saw its operating margins increase 0.5% year-over-year, while CVS Caremark Corporation (NYSE:CVS) increased 1% year-over-year. Therefore, both companies saw strong gains in margins, and expect further long-term expansion. But these gains were nothing compared to Rite Aid.
In Rite Aid’s most recent quarter, it saw operating margins of 1.5%, compared to an operating loss of 1.3% in the year prior. This shows a significant industry leading level of improvement for Rite Aid, but because its margins are so much lower than its competitors, it still has the room to improve for many years to come.
With that said, generic introductions will continue to be introduced for the next several years. Thus, margin improvements will also continue. With Rite Aid Corporation (NYSE:RAD) having just a fraction of the margins as its competitors; room to improve – and the deepest discount to sales – I think a long-term hold could also be very rewarding; as another way to play the stock.
Final thoughts
Right now, shares of Rite Aid Corporation (NYSE:RAD) are trading at $2.75, and already I received countless tweets and emails asking if I thought the stock had bottomed. Unfortunately, I don’t know the answer to such a question, but I do believe that it is possible that we see a period of consolidation and slower gains throughout the second half of this year; due to lower profits in upcoming quarters.
If you have a short-term time horizon, then you might want to consider taking profits into the second half of the year. However, you must keep in mind that there is still unprecedented value in this stock, and the market could very well look past short-term weakness and see the bigger picture. Personally, I have already bought back the 5,000 shares I sold, and I am in this for the long-haul; because the chance of getting left behind is far greater than that of seeing large losses.
The article After a 6-Month 200% Gain, Here Are Two Ways You Can Play This Stock originally appeared on Fool.com and is written by Brian Nichols.
Brian Nichols is long RAD. The Motley Fool has no position in any of the stocks mentioned. Brian is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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