Is Rite Aid Riskier than Investors Realize?

Source: Wikimedia Commons

One of the hottest turnaround stories in recent years has been Rite Aid . Although the drugstore chain is the third largest in the United States, it has been struggling for years against CVS Caremark and Walgreen , its two larger competitors. In spite of its challenges, the retailer's revenue has stayed virtually flat and its bottom line has improved tremendously, which resulted in Mr. Market boosting its shares up 175% from their 52-week low. But is it too soon for shareholders to rejoice? Even though the company's financial situation is improving, there are some big downsides to holding its stock.

Rite Aid's stores vastly underperform those of the competition
A big indicator of a retailer's performance is its revenue per square foot. By figuring out the average nominal worth of products sold for each square foot of selling space, it's possible to gauge the retailer's performance relative to its peers. For Rite Aid, the situation looks downright awful.

As of the end of its 2013 fiscal year, Rite Aid reported approximately $556 in revenue for each selling square foot across its 4,587 retail locations. In all fairness, this exceeds the $537 in sales per square foot that the business reported five years earlier, as management has moved to close underperforming stores while improving comparable-store sales, but it falls far short of its peers.

Sources: Rite Aid, Walgreen, and CVS

At the end of its most recent fiscal year, rival Walgreen saw its revenue per square foot of selling space come in at $811, 46% more than that of Rite Aid. This marks a reasonable uptick from the $802 per square foot of selling space reported by Walgreen five years earlier, but shareholders should keep in mind that the company's revenue (as measured by this metric) has been on the decline since 2011.

The biggest winner over this period, however, has been CVS. Between 2009 and 2013, the retailer saw its revenue per square foot of selling space climb 17% from $1,449 to $1,690.

Rite Aid's international presence is minuscule at best
Currently, Rite Aid has no operations outside of the U.S. While this may not seem like a big deal, the fact of the matter is that remaining U.S.-centric may put Rite Aid even further behind its rivals, given that GDP growth in developing countries is expected to outpace GDP growth in developed ones.

In contrast, both Walgreen and CVS have footprints abroad. For CVS, this takes the form of 45 stores in Brazil, while Walgreen is in talks to acquire the rest of Alliance Boots.

Source: Alliance Boots

In 2012, the drugstore chain purchased a 45% stake in Alliance Boots for $6.5 billion and gained an option to buy the remaining 55% of the company for $9.5 billion between Feb. 2 and Aug. 2 of 2015. Using 2013's revenue, this would increase the company's sales from $72.2 billion to $110 billion and would allow the business (if shareholders can persuade management) to move its tax base to Switzerland, effectively decreasing its corporate tax rate by nearly half.

Rite Aid's debt could be a pressing concern
In addition to the issues previously discussed, there's also the matter of Rite Aid's high debt. Although the business has moved from annual losses to annual gains and its debt levels have been improving over the past five years, the fact that its $5.7 billion in debt equals 22% of the company's trailing-12 month revenue isn't something to brush aside.

To put this into perspective, both Walgreen and CVS have less debt than Rite Aid as a percentage of sales, based on their most recent revenue and balance sheet data. Currently, CVS' ratio stands at 10% of trailing-12 month sales while Walgreen's is even lower at 6%.

This disparity does not mean that Rite Aid will suffer because as long as management can keep the earnings and cash flow of the business positive, its debt burden shouldn't be too much of an issue. However, in the event that the drugstore chain sees bad times come again, this is something the Foolish investor should watch very closely.

Foolish takeaway
None of what I wrote implies that Rite Aid is a terrible investment. In fact, given the company's improvement in recent years it's entirely possible that the retailer can continue its winning streak. But these weaknesses do point to a picture in which the company may not be such a no-brainer but may, instead, be riskier than what some investors have been led to believe.