Rite Aid on right track for fiscal 2009

CAMP HILL, Pa. —Rite Aid is one month shy of completing systems conversions across its acquired Brooks/Eckerd store base—as of earlier this month, conversions to Rite Aid’s NexGen pharmacy system had been completed in some 1,300 stores, or 75 percent of the Brooks/Eckerd store base.

The chain is two months shy of folding Brooks/Eckerd same-store sales into its own comparable-period sales results. And while those Brooks/Eckerd stores are currently trending negative in same-store sales results, those figures ought to flip positive and provide a boost to Rite Aid’s overall sales results once prior-to-Rite Aid heavy front-end promotions are cycled through—and even more so once Rite Aid’s conversion of those stores, from the back-end information technology systems through the front-end product mix, is cycled through well into next year. “We expect margins in these stores to continue to improve as we cycle aggressive pre-acquisition promotions and continue to increase their generic-dispense rate and private-brand penetration,” stated Mary Sammons, Rite Aid chairman, president and chief executive officer, to analysts earlier this month. “We expect same-store sales trends at the acquired stores to turn positive in the third quarter of the year,” she said, noting that overall sales at the acquired stores were below what Rite Aid expected when it took the reigns in June of last year, “much of the decrease is likely due to the nine months it took to complete the transaction,” Sammons said.

And Rite Aid is six months shy of taking the last vestiges of Brooks/Eckerd from the retail landscape. After taking a hiatus for the holidays in December, Rite Aid has worked up toward executing 60 minor remodels per week since February. To date, more than 450 stores have been completely transformed.

Rite Aid’s private-label penetration across the Brooks/Eckerd network already has improved some 200 basis points since the chain acquired the East Coast retailer last June, and some 125 former Brooks/Eckerd locations now boast a GNC vitamin and supplement department—the majority of 350 additional GNCs will be added to the Brooks and Eckerd stores this fiscal year—which, on a category basis, provides a comparable sales boost three times greater compared with Rite Aid supplement departments without the GNC branding.

In other words, Rite Aid is right on course with its initial plans of assimilating the Brooks/Eckerd stores into the Rite Aid mix. The only projection that’s really changed since Rite Aid acquired Brooks/Eckerd almost a year ago is the capital expenditures commitment the chain planned to make this year—from a projection of around $700 million to $600 million on account of the weaker economy. “As we’ve said in the past, we are recession-resistant, but not recession-proof,” said Kevin Twomey, Rite Aid executive vice president and chief financial officer. Accordingly, Rite Aid has scaled back its capital expenditures in anticipation that the current economic climate will get worse before it gets better.

Brooks/Eckerd conversions aside, a weakened economy is of particular concern not only to Rite Aid, but all drug store retailers. While a weakened economy may entice consumers to trade down more aggressively toward generic medicines and store-brand alternatives, it also will force retailers into being a little more promotional on the front end to prevent any kind of mass exodus to such deep discounters as Wal-Mart.

Rite Aid already appears to be well-positioned in its promotional strategy going forward. The chain reported a front-end same-store sales increase of 5.7 percent, including a 300- to 400-basis-point benefit from an early Easter, compared with last year. “We had been looking for 2 percent front-end comps, including [an approximate] 80 basis points from Easter,” noted Lehman Brothers analyst Meredith Adler in an April 4 research note. “Thus the actual underlying run rate of [around] 2.2 percent was above our base case forecast of [around]1.2 percent, and was on pace with the recent trend despite the ongoing economic slowdown,” Adler said, noting that the tail end of the flu season was neutral to front-end comps and that there was a slight lift from the Rx-to-OTC switch of McNeil Consumer’s Zyrtec allergy remedy.

“Although results for fiscal 2008 were not as strong as we had planned when we started the year, we continue to set the stage for our future long-term growth with our Brooks/Eckerd acquisition, our integration activities, our sales and expense control initiatives and the increased depth we added to our senior management team, especially in operations,” Sammons told analysts.

It’s the company’s focus on core market growth that prompted Rite Aid to load up on 12 Pharm Drug Stores in the Toledo, Ohio, area in an acquisition from Spartan Stores last month, in a deal that’s expected to close this summer. “In contrast, [it’s also] why we sold our stores in Las Vegas, which has never been a core market for Rite Aid,” Sammons said.

The No. 3 drug retailer reported a net loss of $1.1 billion for its fiscal 2008 ended March 1, which included only three quarters of results from its acquired Brooks/Eckerd operations. “Without the impact of [a] tax charge, and the resulting loss of a tax benefit in the fourth quarter, we would have reported a net loss that was within our guided range,” Sammons said, noting that the net loss would have been around 29 cents per share versus the $1.54 loss per diluted share that the chain recorded for the year.

Rite Aid recorded $24.3 billion in overall revenues for the year, an increase of 39.8 percent. Rite Aid’s adjusted EBITDA was tallied at $962.8 million, or 4 percent of revenues for the year, compared with $696.9 million or 4 percent of revenues for last year. Analysts had expected Rite Aid’s EBITDA to be slightly higher—between $970 million and $975 million, or just below the midpoint of Rite Aid’s 2008 guidance.

Same-store sales for the 52-week year increased 1.3 percent (not including Brooks/Eckerd operations), consisting of a 1.7 percent pharmacy same-store sales increase and a 0.7 percent increase in front-end same-store sales.

Providing guidance for fiscal 2009, which ends Feb. 28, Rite Aid expects to cut those net losses to less than $375 million on sales ranging between $26.7 billion and $27.2 billion, and same-store sales (which at that time will include nine months of sales from the Brooks/Eckerd stores) to improve 2 percent to 4 percent compared with fiscal 2008. Adjusted EBITDA is expected to fall between $1 billion and $1.1 billion.