CVS - Rite Aid Q1 Earnings Preview: Bears Remain In Control

2023-06-27 13:02:23 ET

Summary

• Bears remain resolute in their strong bet against Rite Aid.
• Weak outlook from Walgreens hurt RAD stock ahead of the Q1 2024 report.
• Debt leverage and cost run rate remain a concern.

Walgreens Boots Alliance ( WBA ) lost 10% when the pharmaceutical retailer failed to meet investor expectations. Its lowered outlook sets a sour outlook for Rite Aid ( RAD ), which reports its first quarter results for fiscal 2024 on Thursday, June 29, 2023. Ahead of Rite Aid posting Q4/2023 results , investors needed evidence that the business improved. Instead, the stock lost 35% and rewarded short-sellers. Bears have a 24.63% short interest against RAD stock.

Markets will reward their bearish bet if the company posts weak results and further evidence of insolvency.

Rite Aid Fourth Quarter 2023 Recap

In the last quarter, Rite Aid reported a loss of $4.39 a share , missing consensus estimates by a wide margin of $3.22. Elizabeth "Busy" Burr, interim Chief Executive Officer, tried to spin the results in a positive light. Burr said that its "fourth quarter results were at the higher end of our guidance and above consensus, driven by encouraging results in retail pharmacy and year over year improvement for the quarter at Elixir."

Elixir is a subsidiary that provides specialty generic medication enhancement. Members may receive generic versions of certain medications at a zero-dollar co pay. It's a pharmacy benefit management ("PBM") that it acquired for $2 billion in 2015 .

Elixir did not show signs of strength. The firm posted revenue falling from $24.6 billion in the prior year to $24.1 billion for FY 2023. COVID vaccine and testing revenue fell. Store closers and the loss of commercial clients at Elixir weighed negatively on revenue.

Elixir is a core strategy in Rite Aid's attempt to increase client retention. This includes offering improved reporting and pricing to demonstrate its competitiveness. It already secured three of its top five renewals as a result . In Q4, the net loss of $241.3 million included an impairment charge for goodwill worth $119 million from Elixir.

Rite Aid posted improved SG&A (sales, general and administrative). The medical loss ratio at Elixir Insurance contributed to the savings.

FY2024 Outlook

For the second half of fiscal 2024, Rite Aid expects a higher adjusted EBITDA. It cited the timing of its performance acceleration and cost reduction initiatives. Unfortunately, those catalysts will not show up at an accelerated pace for another two years. Shareholders would need to wait until fiscal 2025 and 2026 before Rite Aid's adjusted EBITDA grows meaningfully.

Revenue of between $21.7 billion and $22.1 billion in fiscal 2024 is slightly above the consensus of $20.88 billion. It will lose between $439 million to $466 million. This is an adjusted net loss per share of ($4.44) and ($4.93).

For the upcoming quarter (FQ1 2024), expect the firm to lose $1.57 a share . Readers should have low confidence in the forecast since the data compiled relies on only one analyst.

Opportunity

Mounting losses limit Rite Aid's opportunities. It set a $190 million target for savings in the last quarter, helped by closing 190 stores this year. In the fiscal year ahead, it will close fewer stores. Payroll is as lean as it can be. To grow scripts and its business, Rite Aid needs to invest in talent and technology.

The company expects to reduce inventory by more than $40 million. It will need to manage merchandise levels at a regional level. This will improve its inventory ordering activities.

Rite Aid has an opportunity to reduce prescription inventory, especially for branded products. Executive Vice President and Chief Financial Officer Matt Schroeder said the stores may lower such inventory without hurting customer service or delivery times.

Risks

Rite Aid's overleverage is the highest risk to the business. Its long-term debt, less current maturities, increased to $2.92 billion, up from $2.73 billion the year before. Gross capital expenditure was $225 million for both years. Such investments in technology must drive a rapid payback. The firm needs to report better script adherence and lowering inventory. In addition, Rite Aid must post momentum from Elixir.

The leverage ratio is at 6.5 times. Currently, Rite Aid's investments failed to grow EBITDA. The CFO said on the conference call that those efforts need to boost EBITDA in 2025 and 2026. If it fails to generate cash flow to lower its leverage ratio, the chances of defaulting on its debt increase.

Related Investments

Walgreens skillfully acquired 2,186 of Rite Aid's 4,523 stores for $5.175 billion in 2017 . Back then, it looked like Walgreens would grow market share and profit margins. Today, the competitor looks vastly weaker. Significantly lower demand for COVID-related services and a weaker economy are the headwinds that CEO Rosalind Brewer cited .

Before the warning, WBA stock paid a dividend that yielded 6.08%. If business conditions worsen, the firm may slash dividends. Advance Auto Parts ( AAP ), Newell Brands ( NWL ), and Paramount Global ( PARA ) are examples of companies that did that to preserve cash flow. Advance Auto Parts cut dividends by 83% , Newell cut dividends by 70% , and Paramount cut dividends by 79% .

CVS Health ( CVS ) recently traded below $70 on concerns about managed care costs . Fortunately, UnitedHealth ( UNH ) stock "double bottomed" at $460. Buyers took advantage of UNH's increased cost warning.

Your Takeaway

Investors should not expect a breakthrough earnings rebound. Rite Aid faces the same pressures as its peers. Any progress of its initiatives helping to cut inventory and increase revenue might help its share price after the earnings report.

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