Strong store performance drives share

Drug Store News, July 21, 2003

A little more than three years ago there were analysts on Wall Street that may very well have had Rite Aid on bankruptcy watch. Of course, that was then.

In the last four months, the company's stock has grown more than 110 percent, falling just shy of $5 a share by the second week of July. In fact, the performance of Rite Aid's shares in the month of June was the reason, Smith Barney analyst Lisa Cartwright said in a July 3 conference call on retail drug stocks, that the drug sector, up 6.4 percent last month, managed to outperform food retailers (up 3.1 percent) and the S&P 500 (up 1.1 percent). "The majority of that outperformance is Rite Aid," she explained.

That is a direct reflection on the strength of the current management team, the plan it put in place to pay for the sins of the management team that preceded it and its ability to foster a strong commitment to that plan throughout every level of the organization--from Camp Hill, Penn., all the way back out to the stores.

"Rite Aid has not only done an outstanding job on re-engineering its balance sheet when Chapter 11 looked like a distinct possibility, Merrill Lynch retail analyst Mark Husson wrote in a spring report, "but the highly respected management team has really sharpened up retail execution after years of under-management." That was in April when the company's stock was still trading at $2.60.

Since then, Rite Aid has managed to gain approval for a refinancing program--which extends the company's debt load another three years, maturing in 2008--and, importantly, has continued to deliver improved store operations and higher than anticipated EBITDA performance. Rite Aid reported first quarter EBTDA of $175 million--about $12 million better than some analysts had projected--an increase of 11 percent over the same period one year ago.

And while a good deal of that is a factor of the chain's growing ability to control its costs as a percentage of sales, the upside was fed at least equally by improved gross margin, a direct reflection on the success Rite Aid, has had improving store performance. It seems management clearly focused on balancing both sales and margins by promoting less and letting benefits from strength in higher-margin generics flow through to the EBITDA line," Cartwright noted in a June 24 report on the company.

Certainly, Rite Aid has begun to show some improvement on the pharmacy side of the business, but its strength over the past several months--not to mention a major contributor to its improved gross margin situation--has been at the front end of its stores. Rite Aid's same-store sales growth has outpaced the retail drug average in each of the past 11 months.

Having come so far, and with more capital to invest in growing the business--at the end of the first quarter management announced that it had raised total capital expenditures estimates for the year from $150 million to $170 million to $190 million--executives announced at Rite Aid's June 25 shareholders meeting that the chain would begin to add again to its store base in a meaningful way. Next year, it plans to add 75 net new stores, and 100 more the year after that, a decision that has met mixed reviews among the analyst community.

On one hand, there have been some who have cautioned that just as Rite Aid has come so far improving the performance of its existing stores, the company should continue down this road rather than become distracted by growing square footage.

On the other hand, Husson commented, "As Rite Aid begins to embark upon its news store program some time next year, we think it will put some pressure on SG&A ... but at the same time, we remain comfortable with its ability to generate EBITDA growth in the 8 percent to 10 percent range through productivity improvements."

Certainly the company has a plan in place for keeping the momentum alive on EBITDA growth--which, barring any real net earnings, has come to be the key valuator of the chain's stock price. The company has instituted a four-point plan for reaching its goals. Rite Aid's EBITDA Achievement Program is the law of the land from chairman and chief executive officer Bob Miller and president and chief operating officer Mary Sammons out the to stores, and is based on four key pillars:

* Growing prescription counts--includes separate initiatives for recruiting, retaining and training pharmacy staff, increasing file buys as well as customer recapture programs

* Growing front-end sales--particularly, in the chain's most critical categories such as beauty (Read: Glam Camp, expanded ethnic business)

* Containing expenses--specifically, through increased use of labor management and workflow efficiency programs

* Improving customer satisfaction--through a focus on convenience, consistency and improving the on-the-job experience of Rite Aid associates.

The tale of the register tape
Same-store sales: Rite Aid versus retail drug

                Jun-02  Jul-02  Aug-02  Sep-02  Oct-02  Nov-02

Rite Aid
Total            7.9%    7.9%    6.2%    8.7%    6.3%    5.6%
Pharmacy        11.8    11.0     9.9    11.3     9.4     8.6
Front end        1.8     1.8     0.4     4.4     1.1     0.7

Drug retail
 average
Total            7.7%    6.9%    6.0%    7.5%    5.4%    6.6%
Pharmacy        11.2    10.7     9.7    11.5     8.6    10.5
Front end        2.7     1.2     0.5     1.4     0.1     0.3

             Dec-02  Jan-03  Feb-03  Mar-03  Apr-03  May-03  Jun-03

Rite Aid
Total         5.7%    5.7%    3.2%    2.4%   5.9%    4.5%    5.2%
Pharmacy      9.1     7.1     4.9     4.9     5.1     5.9     6.5
Front end     1.5     3.1     0.4     0.4     7.2     2.0     2.9

Drug retail
 average
Total         3.7%    4.2%    3.2%    0.9%    4.9%    2.8%    N/A *
Pharmacy      7.5     7.1     5.8     5.6     4.9     5.5     N/A *
Front end    -0.7    -0.3    -1.0    -6.6     4.8    -1.2     N/A *

Source: Smith Barney. Drug Store News

* Drug retail average includes Walgreens, CVS, Rite Aid, Eckerd
and Longs; June same-store sales for Longs unavailable at press time

Sales per square foot
Merchandising enhancements bear fruit

2000         $380
2002         $537

Source: Smith Barney, company reports

Note: Table made from bar graph.

The market takes note
Rite Aid share price more than doubles since March

113%

3/10/03      $2.65
4/9/03       $2.65
5/9/03       $3.67
6/9/03       $3.74
7/9/03       $4.97

Source: Drug Store News

Note: Table made from line graph.