Is Rite Aid or Walgreen a Better Buy?

Revenue and market share

Walgreen and Rite Aid have both grown through acquisitions; however, Rite Aid’s purchases of Eckerd in 2007 saddled it with debt and integration challenges that contributed to significant losses and a share price below $1 during the recession.

As a result, while Walgreen has continued to acquire and build new stores, Rite Aid has been closing non-performing and over-lapping stores in a bid to improve profitability.

•Walgreen operates 8,217 drugstores.•Rite Aid operates 4,581 drugstores.•Walgreen owns nearly 20% market share.•Rite Aid owns roughly 7% of the market.

Revenue and market share continuedWalgreen posted first quarter sales of $19.5 billion, while Rite Aid generated sales of $6.5 billion.

At Walgreen, sales were up 5.9% from last year. Rite Aid’s sales were up 2.7%, which is still solid given it operated fewer stores.

However, Walgreen posted better comparable store growth versus last year in both the front and back of the store.

A closer look at pharmacy salesPharmacy headwinds caught both drugstores flat-footed last quarter. Lower reimbursements and higher generic prices weighed down overall profitability. However, both companies are guiding for better Rx margin for the remainder of the year as more generics launch and pricing efficiencies are realized. The impact of those Rx margin headwinds was felt more at Rite Aid given that it gets roughly 4% more of its total revenue from its pharmacy than Walgreen. That suggests Rite Aid’s profit is likely to be more volatile over time than Walgreen due to regulatory hurdles, but could also benefit more from aging boomers who tend to fill more prescriptions.

ProfitabilityWalgreen’s sheer size gives it a slight edge in negotiating with suppliers and that was evident last quarter. Walgreen’s cost of goods sold was 71.96%, 15 basis points less than Rite Aid’s. Rite Aid hopes it can make up some of that ground thanks to its purchasing and distribution deal with McKesson, but only time will tell if it can close the gap. Meanwhile, Walgreen continues to reap buying synergies by consolidating purchases across its stores, Alliance Boots, and AmerisourceBergen.

However, it’s not just buying power that works to Walgreen’s advantage. The company is also doing a better job containing SG&A costs than Rite Aid. Last quarter, Walgreen’s SG&A relative to sales was nearly 2% lower than Rite Aid’s That helped it deliver operating margin significantly higher than Rite Aid.

Free cash flowBoth companies are generating significant cash that can be deployed for growth. Although Walgreen creates far more free cash than Rite Aid, Rite Aid’s free cash has been growing steadily over the past five years thanks to its restructuring. Meanwhile, Walgreen’s has been more stagnant.

Debt to capitalRite Aid is far more indebted than Walgreen, which could impair the company’s ability to invest in new stores or programs. However, Rite Aid deserves credit for restructuring its debt to lower its interest expense. Regardless, its debt level continues to expose shareholders to more risk than Walgreen. Investors should keep an eye on this measure to make sure it continues to improve.

Growth opportunityRite Aid and Walgreen benefit from significant growth tailwinds. More than 8 million signed up for new insurance coverage under Obamacare and another 3 million are newly covered under Medicaid. Additionally, with 10,000 boomers turning 65 every day, script volume is set to climb significantly.

In addition to script volume, these factors should also boost demand for in-store clinics. CVS remains the

leader with 800 in-store clinics, but Walgreen expects to have 500 by year end and Rite Aid is getting in on

the act through its RediClinic acquisition in April.

Rite Aid has more expansion opportunity given its absent from key markets like Florida.

Fool-worthy summaryRite Aid has enjoyed an amazing run as its returned to profitability. Analysts are projecting that its earnings per share could grow from an estimated $0.30-$0.40 this year to more than $0.60 in fiscal 2018.

While Rite Aid’s financials make it riskier, investors won’t have to pay up for shares relative to Walgreen. Rite Aid’s forward P/E ratio is 16, while Walgreen’s is 19. Since both companies have tailwinds, it seems Walgreen (which pays a dividend of 1.7%) could be a nice fit for risk averse investors, while the time may be right for aggressive investors to buy Rite Aid.

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