Where Rite Aid Corporation's Q1 Went Wrong

By Markets Fool.com

Source: FoolEditorial on Flickr

Continue Reading Below

Rite Aid Corporation shares tumbled 4% in early trading on Thursday following the company's first quarter financial update. What happened? Here are the highlights of the pharmacy chain's results and the key reasons for investors' disappointment.

By the numbers
First quarter revenue came in at $6.647 billion. That represented a 2.8% increase from the $6.465 billion reported in the same quarter last year. Analysts expected revenue of $6.65 billion.

On the earnings front, Rite Aid announced net income of $18.8 million, or $0.02 per diluted share.During the same quarter of 2014, the company generated net income of$41.4 million, or $0.04 per diluted share. Consensus expectations on Wall Street were for earnings of $0.03 per share.

Rite Aid updated its fiscal 2016 guidance to reflect its pending acquisition of pharmacy benefits manager EnvisionRx. Full-year revenue is now anticipated to be between $30.7 billion and $31.2 billion. Analysts had previously expected revenue of $27.26 billion prior to the EnvisionRx buyout. Rite Aid also lowered its fiscal 2016 earnings guidance to $0.14-$0.22 per share from the $0.19 to $0.27 per share provided earlier in the year.

Behind the numbers
First, Rite Aid's year-over-year earnings decline isn't really that troubling. The lower earnings stemmed from the company's buyout of EnvisionRx. Adjusting for interest and other costs related to this transaction, Rite Aid's first quarter earnings picture looks much better.

Continue Reading Below

There were two real areas of concern in Rite Aid's announcement, though. While the overall revenue numbers basically hit the figures that Wall Street expected, some "under the hood" statistics proved disappointing. Rite Aid's same-store sales increased 2.9% year-over-year, but some had projected an increase of 3.8%. This difference was caused in large part by the introduction of new lower-cost generic drugs.

The other more obvious issue for Rite Aid investors was the lowered full-year earnings guidance. One big factor is that the company plans to spend $665 million on capital improvements; another major drag comes from $455 million in interest expense.

Looking ahead
It's not surprising in the least for a stock to suffer when earnings outlooks are revised downward -- however, I think long term investors should examine the underlying factors for the revision more closely.

Is spending on capital improvements a good thing? In many cases, the answer is a resounding "yes". I suspect that strategic capital improvements, particularly if they're related to expanding wellness programs in stores, will pay off for Rite Aid over the long run.

Is getting into pharmacy benefits management a smart move? Again, the answer seems to be that it is. I would argue that Rite Aid probably should have jumped into the PBM business in a major way a lot sooner than now.

Even the hit that the introduction of new generic drugs took on same-store sales isn't bad looking at the big picture. Generic drugs bring in lower revenue than their branded counterparts, but they also tend to be more profitable.

This year probably won't turn out to be as great for Rite Aid as investors hoped it would, but the decisions that Rite Aid is making seem to be positive ones. I think there is a pretty reasonable chance that the short term pain will lead to long term gain for patient Rite Aid shareholders.

The article Where Rite Aid Corporation's Q1 Went Wrong originally appeared on Fool.com.

Keith Speights has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.