Will Rite Aid Corp's Earnings Cause Shares to Pop (or Drop)?

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After a stellar 2013 during which shares soared 272%, Rite Aid's stock has tumbled more than 33% from its peak above $8 in May. That drop is due to two consecutive and uninspiring earnings reports that reflected delays in capturing hoped-for cost savings from a new drug distribution agreement with McKessonas well as a generic drug profit squeeze. Given the company's recent track record, it's no wonder that investors are a bit worried heading into Rite Aid's fast-approaching Dec. 18 earnings report.

Interrupting recovery
Saddled with significant debt from its 2007 acquisition of pharmacy drug-store chain Eckerd, Rite Aid struggled mightily through the Great Recession. Just as its costs were climbing, slowing healthcare utilization tied to thinning consumer wallets reduced prescription volume and front-end sales, leading to cash flow collapsing and investors fleeing over bankruptcy fears.

However, thanks to deep cost cuts, including store closures, and a much-needed debt refinancing, Rite Aid has returned to profitability. As a result, the company's profit has recovered, and its shares, which were trading below $1 in 2012, have jumped to more than $5.50.

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Source: Rite Aid

Investor enthusiasm stemming from improving cash flow and earnings fueled considerable hope for shares to continue climbing this year. That hope strengthened when Rite Aid announced a massive drug purchasing deal with McKesson in a bid to cut drug procurement and distribution costs and free up money for expansion. Soon after, the company acquired RediClinic, a 30 location healthcare clinic operating in H-E-B grocery stores in Texas. This move catapulted Rite Aid into the Texas market and offered Rite Aid an opportunity to play catch up to its larger peers CVS Healthand Walgreen & Company, both of which are already operating hundreds of in-store healthcare clinics.

However, excitement over those opportunities has since waned following management's admission that its deal with McKesson has been slow to deliver savings, casting doubt on Rite Aid's earnings growth and how quickly the company can finance expansion plans.

Source: Rite Aid

Three in a row?
In the fiscal first quarter, Rite Aid reported net income of $41 million, down from $89 million last year, and cut its full year earnings per share forecast to between $0.30 and $0.40 from between $0.31 and $0.42.

In the fiscal second quarter, net income surged back, climbing to $128 million from $33 million a year ago, but Rite Aid again cut its full-year forecast, this time dropping it to between $0.22 and $0.33 per share.

That has investors wondering if Rite Aid will warn again when it reports its fiscal third quarter earnings.

If the company is forced to rein in guidance again, it won't be because of lackluster sales.

Rite Aid has already reported its sales results for November and the fiscal third quarter, and they're undeniably solid. In November, sales at stores open at least a year climbed 5.1% from a year ago. Front-end sales edged up 0.7% and pharmacy increased 7.1%, even after factoring in a 2.32% headwind from lower prices tied to new generic drug launches. Looking at Rite Aid's pharmacy performance another way, prescription volume grew by a respectable 4.2% year over year in November. Overall, total sales in November were up 5.6% from a year ago, to $2.571 billion.

Sales for the fiscal third quarter were similarly strong. Sales at stores open at least a year climbed 5.4% year over year as front end and pharmacy revenue grew 1.6% and 7.2%, respectively. That led to total revenue of $6.651 billion in the quarter, up 5.1% from the same period last year.

Since there doesn't appear to be much to dislike in Rite Aid's top line, any risk of disappointment will likely come from either ongoing delays in recognizing the benefit of its McKesson partnership, or a continuing inability to leverage a larger, but less profitable, number of Medicare and Medicaid patients in the face of higher-than-expected generic drug wholesale costs.

Turning the corner
Investors will need to focus on management's comments on those two headwinds during its conference call. Previously, the company has suggested that it would begin seeing benefits from its drug distribution agreement pick up into year end. It's also possible that management has gotten its arms around the generic drug profit squeeze given that similar issues haven't been too much of a factor for competitors. If so, then investor excitement could return as the conversation returns to opportunities for future growth, including new stores and healthcare clinics. On the other hand, if Rite Aid reports that those obstacles will drag down earnings again in the company's fiscal fourth quarter, then shares could slump. Either way, investors will want to pay particular attention to the company's earnings conference call this quarter.

The article Will Rite Aid Corp's Earnings Cause Shares to Pop (or Drop)? originally appeared on Fool.com.

Todd Campbellis long Rite Aid. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool recommends CVS Health and McKesson. 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.