Rite Aid Is a Cautious Buy Ahead of Earnings

After last quarter’s earnings report, you can’t fault investors for applying the “once you’re lucky, twice you’re good” mantra to Rite Aid (NYSE:RAD) stock. The company was clearly a pandemic winner. Drugstores were deemed to be essential businesses during the lockdown periods (and rightfully so). So the company had business coming through the door.

As a result, Rite-Aid posted beat on both the top and bottom lines in its most recent earnings report, including a revenue figure not seen for nearly three years.

RAD stock shot up nearly 40% after the earnings report. However, by mid-September the stock had given up all those gains and more. In the last week of trading, the stock is rallying again. This suggests that investors are expecting another strong earnings report.

And they might do just that. The consensus estimate calls for the company to post earnings of 10 cents per share on revenue of $5.76 billion. Both of those numbers would be in-line with their performance in the same quarter in 2019. That speaks to the company’s strength during the pandemic.

But at shares trading for around $14 per share, can RAD stock move higher? I’m thinking yes, but don’t get too attached to the stock as a long-term play.

Rite-Aid Will Remain an Essential Business

One of the reasons that Rite-Aid is thriving is that it is a Covid-19 testing location. In many cases, individuals can be tested for free. If nothing else, it drove traffic into the stores. That was proven in the company’s most recent earnings report when it said that front-end sales (excluding tobacco) were up 16%.

And while testing for the novel coronavirus will remain an essential part of our nation’s ability to live with the vaccine, so will a vaccine once it’s available. The conventional wisdom is that Rite-Aid may play a role in administering a vaccine (similar to its role in administering flu shots). Of course a vaccine, at least initially, will be more limited in quantity. But the current thinking is that the country would have more widespread availability of a vaccine by the middle of 2021.

Not An Omnichannel Play

Now we get to the less good news for Rite-Aid. Whether it’s next year or 2022, the hope is that life will begin to feel more normal. But some ripples will be felt for a considerable amount of time. We are now a nation that has embraced e-commerce. Many Americans, even senior citizens, are now comfortable with ordering their groceries online and having them delivered to their home.

And the same is true of prescriptions. That’s where things can get dicey for Rite-Aid. Any drugstore chain relies on the strength of its pharmacy business. Already companies like Rite-Aid and Walgreens Boots Alliance (NASDAQ:WBA)were getting squeezed by Walmart (NYSE:WMT). And now Amazon NASDAQ: AMZN is jumping into the pharmaceutical arena in a significant way.

To be fair, Rite-Aid is not ignoring the issue. The company is expanding its partnership with Instacart from select locations to all of Rite-Aid’s 2,400 locations. And early numbers suggest that consumers are becoming more comfortable with the service. Rite-Aid also now offers Pay and Go at all of their stores which allows customers to expedite prescription pickup both in-store and in the drive-thru (where available).

But it just seems likely that Rite-Aid will be losing business on the pharmacy side. And it’s not because the company is poorly managed. It’s just because there is increasing competition.

But that weakness may not be evident until the pandemic eases.

What about the balance sheet?

Rite-Aid did post a 16% increase in its adjusted EBITDA in the last quarter. This number has been falling since 2017. The company also delivered positive free cash flow in 2020. Investors will be looking to see if these numbers are part of a long-term trend or just a one-time occurrence due to the pandemic.

That’s the good news. The bad news, the company is still burning cash. It posted a negative cash flow of $240 million while burning $200 million of cash per quarter to fund day-to-day activities. For investors to get excited that number has to show improvement.

This means that a wait-and-see attitude will be part of the Rite-Aid outlook for not just this earnings report, but the next one and the one after that. Rite-Aid has been considered a turnaround stock candidate for some time. But the problem with turnaround stocks is that sometimes they don’t.

However, the pandemic has given the company a window in which to get its balance sheet in order and enhance its digital selling strategy. Due to the fact that the company should have pandemic tailwinds into 2021, the stock looks like it may have some upside. I wouldn’t go crazy with this stock, but if the company posts solid numbers tomorrow, RAD stock may help you ride out the end-of-year volatility.