Did Rite Aid Corporation Just Ink a Super-Smart Deal?

By Markets Fool.com

Continue Reading Below

Source: Wiki Commons user Specious.

In order to overcome headwinds from slowing sales and sky-high debt, Rite Aid has been closing stores and sweet-talking lenders for years. The pharmacy operator's recently announced acquisition of pharmacy-benefit manager EnvisionRx, however, suggests that the company could be becoming a growth company again.

First, a bit of background
An aggressive acquisition strategy significantly shifted pharmacy retail market share in the past 10 years. Larger regional pharmacy operators like CVS Health and Walgreen Boots Alliance gobbled up independent pharmacies to become national operators. Not to be left out, Rite Aid -- the nation's third biggest pharmacy retailer -- went on its own spending spree that included the $4 billion cash and stock acquisition of Eckerd.

The combination significantly expanded Rite Aid, but it did so at a cost. Financing the deal caused the company's interest expense to swell, and the fact that many of the acquired stores overlapped Rite Aid's existing markets caused sales to suffer as stores cannibalized each other's customers. The onset of the Great Recession, which crimped consumers' wallets and drove healthcare utilization (and corresponding prescription volume) lower, took an additional toll that led to a string of losses and (eventually) to the launch of an aggressive cost-cutting campaign.

Turning the corner
Rite Aid's cost-savings measures, a rebounding economy, and demographic tailwinds that include an aging and increasingly insured America, have returned Rite Aid to profitability.

Continue Reading Below

In the company's most recently reported fiscal quarter, rising prescription volume and solid sales at the front end of its stores allowed Rite Aid's sales to increase by 5.4% year over year to $6.69 billion.

Importantly, a lot more of that revenue dropped to the bottom line during the quarter than in the year before. Rite Aid's net income grew from $71.5 to $104.8 million, resulting in EPS increasing from $0.04 to $0.10 in the quarter.

Putting money to work
Rite Aid's improving financial flexibility is giving it the room necessary to play catch-up to its bigger peers.

Last April, the company acquired the 30 location in-store healthcare clinic chain RediClinic in a move that gave the company entry into the important Texas retiree market and jump-starts the company's entrance into in-store healthcare services.

Rite Aid's plan to open 35 RediClinics in its stores by the end of the fiscal year offers a great opportunity to boost foot traffic and prescription volume, but its acquisition of EnvisionRx could prove to be an even bigger opportunity.

EnvisionRx gives Rite Aid entry into the increasingly important pharmacy benefit manager industry, an industry that is growing thanks to self-insured businesses and health insurer's focus on cutting costs.

Pharmacy benefits managers like EnvisionRx pool together buying power to negotiate lower prices with drugmakers. They also actively engage with patients to encourage the use of generic alternatives and to boost adherence and prevent costly hospitalizations.

Source: Rite Aid Corporation.

EnvisionRx is tiny compared to CVS Health's Caremark pharmacy benefits business, which has $76 billion in revenue, or Express Scripts, which has sales north of $100 billion, but it's a growing business that has seen its sales climb from less than $2 billion in 2011 to an estimated $5 billion in 2015.

Envision's already rapid growth could accelerate even more once it's integrated into Rite Aid. That's because Rite Aid's retail footprint may allow it to more effectively compete with integrated pharmacy and PBM operators like CVS Health for bigger contracts.

Looking forward
Although Rite Aid expects the deal to boost earnings on day one, investors shouldn't expect that the EnvisionRx business is going to provide substantial earnings out of the gate. The pharmacy benefit business operates on razor-thin operating margins that are measured in the low single digits.

Regardless, the acquisition marks another important step in Rite Aid's transition from a company that is contracting to one that is expanding, and as a result, investors are likely right to applaud this deal.

The article Did Rite Aid Corporation Just Ink a Super-Smart Deal? 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.The Motley Fool recommends CVS Health and Express Scripts. The Motley Fool owns shares of Express Scripts. 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.