The Rite stuff: Mix of industry trends, cost control benefit Rite Aid

Rite Aid reported its third consecutive profitable quarter Thursday, with profits of nearly $90 million, following the introduction of the largest expansion of its Wellness+ loyalty card program, dubbed Wellness65+, and days before the promotion of COO Ken Martindale to president of the company.

The 4,615-store drug chain has been on a roll lately, continuing to benefit from the switch from branded to generic drugs and the retention of customers from last year's dispute between Walgreens and Express Scripts.

Pharmacy retailers benefit from the generic wave because, while cheaper generics can hurt sales, they yield a marginal benefit that creates greater volume and thus greater profitability, which is why Rite Aid noted the nearly 4.6% offset from new generics when reporting its 3.8% decrease in pharmacy same-store sales. As for Express Scripts customers, the company reported it retained around 75% of them and had a 0.1% decrease in same-store prescription count, compared to an estimated 75% to 80% of those patients, and a 3% increase in same-store prescription count in fourth quarter 2013. Meanwhile, adjusted EBITDA increased by $344.8 million, compared with $274.2 million in first quarter 2013.

So the big question now is, will the good times continue to roll?

First, it's important to bear in mind that Rite Aid was not simply a recipient of good luck and beneficial industry trends. As Credit Suisse analyst Edward Kelly noted in a research note following the results, another major factor has been strong cost control, and Credit Suisse has continued giving the company an "Outperform" rating. Even before Walgreens-ESI, Rite Aid was already narrowing its quarterly losses. "While it's clear that Rite Aid is benefitting from industry tailwinds, internal execution also remains strong," Kelly wrote.

At the same time, the generics wave is expected to start winding down later this year, but the Patient Protection and Affordable Care Act will also take effect in calendar year 2014. CFO and chief administrative officer Frank Vitrano noted during an earnings call with investors Thursday morning to announce the quarter's results that the company's fiscal 2014 outlook does not include benefit from the Affordable Care Act because it will only be in effect for two months of the fiscal year, which ends in mid-2014.

But as president, chairman and CEO John Standley said, an estimated 90% of the chain's pharmacy customers shop the front end of the store as well, and it's on the front end that Rite Aid saw positive same-store sales growth in first quarter 2014, while the company's fast-growing Wellness store format has also tracked higher than the older stores in front-end sales. While Standley was hesitant to give any precise estimates of how the healthcare reform law might affect Rite Aid, he did say, "I think, if you were trying to estimate down the road when things are fully implemented, what it might look like, if you had a sense for the addressable population that you thought was going to come to market, and you sort of looked at our market share, that's probably the best proxy that we can give you at this point to make some sort of estimate in terms of what the impact could be down the road."

Much of Rite Aid's business is focused on the pharmacy. That's the whole point of the Wellness Ambassadors, to provide a "bridge" to the pharmacy, as well as the Wellness+ program, which provides the greatest benefit to customers who fill their prescriptions at Rite Aid, and whose members also happen to be the chain's best customers. And the launch of Wellness65+ was significant because elderly, poly-chronic patients — those with multiple chronic conditions — are also among the chain's most important customers. Considering that about 30 million people are set to gain health insurance with the Affordable Care Act, that means a whole bunch of people who could stand to benefit from a program like Wellness+.