A Stock to Sell: Despite its shares bouncing back, Rite Aid struggles with debt and stiff competition

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Rite Aid (symbol RAD on New York; www.riteaid.com), is one of the largest drugstore chains in the U.S., with 4,623 outlets in 31 states and Washington, D.C.

The stock has shot up to $6.95 from just $1 at the start of 2013, as the company has returned to profitability. Rite Aid showed its first profit in late 2012 after facing five years of losses—and the prospect of bankruptcy due to its huge debt.

Rite Aid’s profits have rebounded as the company has cut its costs. It has also made a number of other moves, such as shifting to generic drugs (which are more profitable for Rite Aid than branded treatments), expanding its customer loyalty programs and linking patients and doctors with its Health Alliance computer system.

In the three months ended March 31, 2014, the company’s earnings fell to $41.4 million, or $0.04 a share, from $89.7 million, or $0.09 a share, a year earlier. Revenue rose 2.7%, to $6.5 billion from $6.3 billion.

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Investment advice: Long-term debt is whopping 74% of Rite Aid market cap

Profits fell for two main reasons: higher-than-expected generic drug costs and a bigger-than-anticipated fall in reimbursement rates from pharmacy benefit managers. (Employers use pharmacy benefit managers to keep their drug costs down. Pharmacy benefit managers negotiate discounts from drug makers so their clients can provide drug benefits to their workers at lower cost.)

Profit growth will likely rebound over the next few quarters, but the company’s debt is still a huge risk factor—its long-term debt of $5.5 billion is a very high 74% of its $7.4-billion market cap. Rite Aid also operates in a highly competitive market with major competitors like CVS Caremark and Walgreen.

The stock trades at 21.1 times this year’s forecast earnings of $0.35 a share.

We don’t recommend Rite Aid and if you hold the shares, we advise you to sell.

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