Rite Aid Corporation (RAD): This Company Is Making a Killing on the Patent Cliff

Even-though the stock has more than tripled from then on going from a low of $0.95 back in December to its current trading price around $2.89 as of May 21, 2013, and this represents a steep increase in price over just a 5 months period, the stock is still relatively cheap compared to its peers.

Two risk factors

While Rite Aid is likely to continue to benefit from an increase in generic drug sales volume, two risk factors come to mind. The first is competition with giant big box retailers such as Costco Wholesale Corporation (NASDAQ:COST) and Wal-Mart Stores, Inc. (NYSE:WMT) who use the pharmacy as a sort of traffic generator rather than a profit center. These stores, especially Costco Wholesale Corporation (NASDAQ:COST), charge significantly less than the big pharmacy chains for generic medications, and may capture a greater portion of generic drug sales in the future.

The second risk factor is declining top line revenue. While revenue growth is not a primary concern at this stage, if revenue continues to decline, then higher margins are going to be needed in order to cover fixed costs. At a certain point the company might revert back to posting losses. If we assume that gross profit margin is 30% and the company’s cost structure remains intact, then Rite Aid Corporation (NYSE:RAD) needs somewhere around $23.5 billion to break even; anything lower will likely result in losses. Management projects annual revenues for the current fiscal year to be $24.9 billion to $25.3 billion.

Foolish final thoughts

As more generic drugs hit the market, Rite Aid Corporation (NYSE:RAD) is poised to benefit by increasing volumes and margins. The company generated $500 million of levered free cash flow in the last fiscal year, and it can use said cash flow to pay off debt and reduce its interest expense, resulting in even greater profitability. However; this company is still not without its risks, so I wouldn’t go betting the entire farm.

The article This Company Is Making a Killing on the Patent Cliff originally appeared on Fool.com and is written by Mohammed Shaaban.

Mohammed Shaaban has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Mohammed 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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