Rite Aid confident despite projection drop

NEW YORK —Rite Aid’s brass may have lowered its earnings projections for its fiscal year 2008 last month, but management says the Brooks/Eckerd conversions are still on course, and the company is primed to realize its full future growth potential. “Remember that Rite Aid is not only a quarter-by-quarter story but a company with a long-term strategy and vision that we believe will make us very successful in the future,” Mary Sammons, Rite Aid president and chief executive officer, said during an analyst conference call last month. “While we will continue to feel the temporary impact of one of the biggest integration efforts in our industry’s history, when we’re through, we expect Rite Aid will be a formidable drug store company with tremendous capacity to create shareholder value.”

Rite Aid lowered its fiscal 2008 guidance because of a sluggish start to this year’s cough and cold season and a soft economy, Sammons said. “Our team is focused on our critical priorities of increasing both front-end and pharmacy sales, containing costs, investing in the store base through our new and relocated store program and improving customer satisfaction.”

“Sales in the stores that have undergone the full conversion to Rite Aid are moving in the right direction, even before they receive the benefit of additional planned marketing support,” noted Jim Mastrian, Rite Aid’s special advisor for corporate strategy, in a December letter to suppliers. The Brooks/Eckerd stores are improving their private-label penetration, which represented less than 9 percent before the acquisition, toward a penetration level of 13 percent.

Over the course of the third quarter, Rite Aid completed systems conversions at 265 stores after having completed 300 by the end of its second quarter. “We continue to be on track to have all of the acquired stores converted and integrated into Rite Aid by fall of next year,” Sammons reported.

Rite Aid had changed all the merchandise at every store by the end of November, which includes the company’s private-label offerings. Rite Aid’s newly acquired Brooks/ Eckerd distribution centers are stocked with 8,500 new items, the retailer reported.

The company is also continuing to invest in new and relocated stores, which adds to the drag on its bottom line. While relocated stores only take some 18 months to reach a break-even point, new stores can take as long as three years.

“We’ll actually have a larger number of stores that begin to enter our comp numbers over the next several quarters,” Sammons said. “[The new Customer World stores] are performing pretty much as we have expected, so we’re confident about that program going forward.”

Rite Aid expects sales to fall between $24.3 billion and $24.6 billion, with same-store sales improving 1 percent to 2 percent, compared with previous guidance of $24.5 billion and $25.1 billion, with same-store sales improving 1.3 percent to 3.3 percent.

Net loss for fiscal 2008, is expected to drop between $161 million and $192 million compared with previous guidance of net loss between $78 million and $161 million.

Rite Aid reported revenues of $6.5 billion for the 13 weeks ended Dec. 1, representing a 51 percent increase. The lowered guidance will not impact Rite Aid’s ability to pay down its debt load in accordance with its covenants, however. “The required maturities over the next three years are less than $175 million,” commented Kevin Twomey, Rite Aid executive vice president and chief financial officer. “The largest component of that is the $150 million note that’s due Dec. 15, 2008.… As we are going through this integration and ramping up the synergies, fiscal 2008 is going to be…a negative free-cash flow [year],” Twomey said, where the operating cash flows will be less than capital expenditures. However, that will change by fiscal 2009, he said.

In the days after Rite Aid lowered its guidance, the company’s shares dropped by some 27 percent to less than $3 per share.

But analysts were undeterred. “We remain confident in the medium- and long-term outlooks for Rite Aid and the benefits of the Brooks/Eckerd merger…although we expect near-term sales pressure to persist into 4Q,” wrote Meredith Adler, research analyst for Lehman Brothers.