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Goldman Sachs: Rite Aid Shares Poised For Further Upside

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Robert Jones, analyst at Goldman Sachs believes that the Drug Chain stores remain an attractive investment, but Rite-Aid (NYSE: RAD) is uniquely positioned to experience greater relative growth compared to the industry as a whole.

Following Rite-Aid's announcement in February that it would be moving its generic purchasing to McKesson all the major drug retailers have a purchasing partner that could create synergies over the coming years.

Rite-Aid announced that it would purchase brand and generic drugs from McKesson, a shift from previously being self-distributed. McKesson is likely to give Rite Aid a beneficial deal on generic pricing to secure its volume as Rite-Aid is likely to purchase $1 billion to $2 billion from McKesson.

According to Jones, Rite Aid's agreement with McKesson should contribute and create $23 million of synergies and $135 million of cash flow which could be used towards furthering Rite Aid's store remodeling initiatives and/or paying down debt as part of the company's strategy of deleveraging its balance sheet.

With $135 million, Rite Aid could remodel an additional 338 stores which could yield $3 million in net earnings based on a two percent sales lift per store. This is the ideal strategy according to Jones as “remodels are critical to improving the long-term viability of the store base.”

In February, Rite-Aid's credit rating was bumped higher to B2 from B3 by Moody's. This allowed the company to refinance a $1.15 billion term loan at a 50 basis point lower rate. The company will save $6 million from this move and according to Jones the company could further refinance its $270 million 10.25 percent senior secured notes when they become callable in October, which could result in a further $7 million savings.

Not too late to invest: Rite-Aid to benefit from Medicaid expansion

Rite-Aid still has plenty of runway left in its transformation and shares have further upside despite an 80 percent move in the stock since September 2013. Rite-Aid is likely to benefit over other Drug Chains.

Jones is forecasting Rite-Aid's comps to improve to 2.5 percent in fiscal 2015 from 0.7 percent in fiscal 2014 on strong script growth and better front-end execution. A large catalyst towards the growth will be Rite-Aid's benefit from ACA and Medicaid expansion.

Rite-Aid has the greatest exposure to states that have expanded Medicaid, with 65 percent of its stores in the 25 states and DC, compared to 47 percent for CVS Caremark and 54 percent for Walgreen. If Medicaid is further expanded in Pennsylvania and Virginia, Rite-Aid would have 81 percent of its stores in a state that expanded Medicaid.

Jones analyzed the demographics of households where Rite-Aid has a store and concluded that the median income in markets with expanded Medicaid is $58,587. By comparison, the average median income near a Walgreen and CVS store is $60,956 and $65,222, respectively. Rite-Aid has a “greater exposure” to lower income households that is expected to benefit the most from Medicaid expansion. As such, Rite-Aid is likely to see a “disproportionate” benefit relative to its peers.

Ratings and price targets

Shares of Rite-Aid were upgraded to Buy from Neutral with an $8 price target.

Shares of Wallgreen were reiterated Buy rated with a price target raised to $79 from a previous $67.

Shares of CVS were reiterated Neutral rated with an unchanged price target of $71.

Latest Ratings for RAD

DateFirmActionFromTo
Oct 2014ISI GroupInitiates Coverage onBuy
Oct 2014Cowen & CompanyInitiates Coverage onMarket Perform
Sep 2014JP MorganMaintainsOverweight

View More Analyst Ratings for RAD
View the Latest Analyst Ratings

Posted-In: cvs caremark Drug Chain Stores Generic drugs McKesson MedicaidAnalyst Color News Analyst Ratings

 

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