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Expiration date?Analysts, stockholders say Rite Aid Corp. in danger, but retail chain says company remains healthy

By , - Last modified: February 15, 2011 at 11:02 AM

A decade ago, Cumberland County’s Rite Aid Corp. pulled itself back from the brink of extinction following a historic accounting fraud scandal.

Today, America’s third-largest drugstore company is in peril again, some observers say, citing the causes as debt, a slumping economy and poor leadership.

Photo illustration/Kathryn Morton
The 4,800-store Rite Aid chain sustained large losses the past three years.

Its debt totals $6 billion, half of that due to the company’s acquisition of the Brooks and Eckerd chains in 2007. Its shares, traded on the New York Stock Exchange under the ticker symbol RAD, have fallen below $1 and could be delisted as a result. On Monday they closed at 93 cents.

Meanwhile, Rite Aid’s competitors look strong. Top chains CVS and Walgreens both posted profits in the second quarter and had share prices in the upper-$20 range this week. Retail behemoth Walmart is expanding in the pharmacy sector, and analysts say business models will come under major new pressures as health care reform changes the rules in the industry.

Rite Aid’s odds of long-term survival are “even money” at this point, said Anthony Liuzzo, director of the MBA program at Wilkes University and a retail analyst who follows the company.

Rite Aid executives strongly dispute such prognostications of doom and gloom.

“I’m very optimistic about the future prospects of our company,” John Standley told investors in a conference call June 23, the day he took over as president and CEO from Mary Sammons, who led the company for seven years and remains board chairwoman.

Rite Aid’s debt is manageable, the company has implemented numerous cost-saving measures, and “there’s a lot going on to boost sales,” Rite Aid spokeswoman Karen Rugen told the Business Journal in a recent interview.

Efficiencies begun during the recession will remain in place as the economy recovers, “and you’ll see more dollars fall to the bottom line,” Rugen predicted.

The road back from 1999

Rite Aid has faced dark days before. Incorporated in 1958 by Alex Grass, Rite Aid opened its first store in 1962 in Scranton under the name Thrif D Discount Center. The company had thousands of stores by 1995 when son Martin Grass became chairman and CEO. Alex Grass died in 2009.

In 1999, Martin Grass was forced out in what was then the largest accounting fraud scandal in U.S. history. Grass eventually pleaded guilty and was sentenced to eight years in federal prison. Five other executives pleaded guilty or were convicted.

Rite Aid, meanwhile, restated its earnings for 1997 and 1998 downward by $1.6 billion. The company’s stock fell from a high of $63.17 in February 1998 to $4.50 in November 1999, a nearly 93 percent decline.

In 2000, a new management team that included chairman and CEO Robert Miller, Chief Financial Officer Standley, and President and Chief Operating Officer Sammons orchestrated a turnaround plan that included billions of dollars in refinancing, the sale of Rite Aid’s prescription-plan administration business and other moves.

Their actions stanched the red ink and boosted sales. Sammons became CEO in 2003, with Miller remaining chairman. Standley left in 2005 to become CEO of Pathmark, returning to Rite Aid as president and chief operating officer in 2008.

In 2004, Rite Aid sought to buy Eckerd from J.C. Penney but lost out to Canadian firm Jean Coutu Group Inc. Three years later, however, Rite Aid bought Eckerd from Jean Coutu along with the Brooks chain, adding more than 1,800 stores. Jean Coutu received an ownership stake in Rite Aid as part of the deal, which cost $3.4 billion and doubled Rite Aid’s debt.

Sammons received a $1.5 million bonus when the deal went through and five other top executives received bonuses totaling just over $2 million, according to Securities and Exchange Commission filings.

“The acquisition will give us the scale to compete more effectively with our major rivals,” Miller and Sammons said in a 2007 letter to shareholders. Credit Suisse Group analyst Ed Kelly called the acquisition a “good strategic fit” that would give Rite Aid economies of scale, according to press accounts at the time.

“I think the acquisition was the biggest mistake they made,” said Matthew Coffina, a stock analyst who tracks Rite Aid for Morningstar.

It was followed by the nation’s worst recession since World War II. Rite Aid lost $1.1 billion in its fiscal year 2008, which ended March 1, 2008, $2.9 billion in fiscal year 2009 and $506.7 million in fiscal year 2010. In March 2009, the stock dipped to 22 cents. Rite Aid has posted 14 straight months of same-store sales declines, compared to three down months and five up months this year for Walgreens and one down quarter and two up for CVS.

At the end of July, the New York Stock Exchange warned Rite Aid its share price had fallen below $1 for 30 trading days and could be delisted if the low price continues.

The firm has six months to raise the price. If stockholder action is needed to approve a remedy such as a reverse stock split, the company will have until its next annual meeting in June.

A tough industry

Skeptics say the company can’t overcome its debt load, given its formidable competition and the recession.

“It’s not a company I’d want to be a shareholder in,” said Coffina, who estimates the company’s fair value at a mere 30 cents per share.

Rite Aid’s operating margin is 1 percent of sales, while its interest expense is about 2 percent, Coffina said.

By comparison, CVS and Walgreens have operating margins of 6.5 percent and 5.4 percent respectively, according to Yahoo Finance.

Rite Aid’s same-store sales are likewise a distant third to its competitors, Coffina said. Annual sales per square foot at Rite Aid were $530 in the most recent fiscal year, compared with $826 at CVS and $856 at Walgreens, he said.

But Rite Aid began paying down debt last year, Rugen said. The company is issuing $650 million in new debt and is rolling over a $1.2 billion revolving loan from 2012 to 2015 at lower interest. That shows investors still have confidence in Rite Aid and interest in financing it, Rugen said.

Fitch Ratings rated the $650 million issue “BB-/RR1.” BB- is a speculative-grade rating indicating “elevated vulnerability to credit risk,” but RR1 indicates “outstanding recovery prospects given default,” according to the rating agency.

The rating reflects Rite Aid’s high debt and its limited capital for investment but also the company’s intensive efforts to cut costs and boost sales, Fitch said.

The economy has curtailed Rite Aid’s ability to spend money on upgrading more stores, “but it’s important to note that we have very strong market share in the north, east and west where we have many high-volume stores,” Rugen said.

Moreover, Rite Aid’s efforts to increase sales are bearing fruit, she said. The chain has enrolled 15 million members in its customer rewards program, “wellness+,” which launched in April, she said. It revamped its private brands; and is refining its market segmentation to boost sales, trying different product mixes and promotions in, for example, urban versus suburban stores, she said.

Shareholders, workers sound off

Still, not everyone is convinced, including some with a financial stake in the company.

Investors have accused company leaders of mismanagement and unwillingness to squarely face Rite Aid’s precarious position.

Angry shareholders dominated the company’s most recent annual meeting, said labor organizer Rand Wilson, a small shareholder who attended.

“Shareholder after shareholder … stood up and blasted management for insider dealing, failed marketing strategy and top-heavy structure,” he said.

Shareholder Steve Krol called out Sammons and Miller at the meeting for their personal use of the company plane, calling it “outrageous,” according to press accounts. The two have spent nearly $1.8 million of company money on flights, he said.

Outside, union organizers protested the company’s alleged stalling in negotiations on a contract with more than 500 workers at a Lancaster, Calif., distribution center.

Distribution center workers voted in 2008 to be represented by the International Longshore and Warehouse Union, despite Rite Aid’s stiff opposition. Union representatives have tried to negotiate a contract ever since, but management won’t listen to them, said Sylvia Estrada, an 11-year employee and a member of the ILWU negotiating committee.

In addition, Lancaster managers are speeding up required work rates to exhausting and unsafe levels and verbally abusing workers, she said.

Top management is letting the distribution center’s managers create a climate of hostility and intimidation and refuses to intervene even when issues are brought to their attention, Estrada said.

Employees “go home crying, they’re so stressed out,” she said.

Elsewhere, Rite Aid is facing several class action suits on behalf of store managers who say the company illegally stopped paying them overtime. The company says the claims are without basis and it is energetically fighting them.

One shareholder contacted for this article listed a litany of problems allegedly witnessed personally: understocked and understaffed stores, persistently poor customer service, managers indifferent to operational problems and a board too cozy with top executives to exercise due oversight and hold management accountable.

“If this company was managed properly, it could run circles around Walgreens and CVS,” the investor said, speaking on condition of anonymity.

Rite Aid appreciates hearing from its stockholders, Rugen said.

Regarding the company plane, “we have a very strict policy regarding personal use,” she said. The company is comfortable with the composition of its board and has confidence in it, she said.

Rite Aid tracks consumer satisfaction carefully, and although large companies will always have a smattering of complaints on websites and message boards, results have improved every quarter, she said.

The company is simplifying procedures to give associates more time to focus on customer service, and 1,200 “cultural ambassadors” within the company are working to spread best practices throughout the organization, she said.

About 30 percent of Rite Aid’s 97,000 associates are unionized, and the company has enjoyed good labor relations for decades, she said.

“We continue to bargain in good faith” with the Lancaster, Calif., workers, she said.

Finger-pointing is typical when companies hit hard times, Liuzzo said.

“These kinds of charges are fairly regular,” he said.

It’s “not impossible” Rite Aid could recover if sales pick up briskly enough, Coffina said. The company is in no immediate danger, he said.

“As long as people are willing to lend to them, they can stay alive indefinitely,” he said.

• • •

A brief history of Rite Aid

1958 - Alex Grass incorporates Rite Aid precursor Rack Rite Distributors Inc.

1962 - First store opens in Scranton as “Thrif D Discount Center.”

1968 - Company officially named Rite Aid Corp., goes public.

1970 - Rite Aid listed on New York Stock Exchange.

1983 - Rite Aid exceeds $1 billion in sales.

1995 - Martin Grass succeeds his father as chairman and CEO. Rite Aid acquires Perry Drug Stores, nears 3,000-store benchmark.

1996 - Rite Aid acquires 1,000-store chain Thrifty PayLess Holdings Inc.

1998 - Rite Aid acquires drug benefits administrator PCS Health Systems Inc.

1999 - Rite Aid partners with General Nutrition Cos. Inc. to offer GNC stores within Rite Aid stores. Martin Grass ousted. Securities and Exchange Commission opens investigation of accounting irregularities. Rite Aid restates earnings. Chairman and CEO Robert Miller, President and Chief Operating Officer Mary Sammons and Chief Financial Officer John Standley take helm as core of new management team.

2000 - Rite Aid further restates its earnings for 1998 and 1999 by more than $1 billion, sells PCS Health Systems Inc.

2002 - Martin Grass and other executives indicted on federal fraud charges.

2003 - Grass pleads guilty, receives 8-year sentence. Sammons named CEO. Miller remains chairman.

2004 - Rite Aid debuts its “Customer World” store redesign. It earns $83.3 million in fiscal 2004, its first profit since the Martin Grass era.

2005 - Rite Aid earns $302.5 million in fiscal 2005. Standley leaves to become Pathmark CEO.

2006 - Rite Aid earns $1.27 billion in fiscal 2006. It announces its intent to buy the Brooks and Eckerd drugstore chains from Jean Coutu Group Inc.

2007 - Rite Aid earns $26.8 million in fiscal 2007. It completes the Brooks/Eckerd transaction, begins integrating 1,600 stores and closing 200.

2008 - Rite Aid loses $1.1 billion in fiscal 2008. Standley returns as president and chief operating officer.

2009 - Rite Aid loses $2.9 billion in fiscal 2009. Stock falls to 22 cents in March. Alex Grass dies in August.

2010 - Rite Aid loses $507 million in fiscal 2010. Standley succeeds Sammons as president and CEO. Sammons named chairman. Rite Aid introduces wellness+, its first free customer rewards program.

Sources: Rite Aid Corp., International Directory of Company Histories, The Associated Press, Yahoo Finance

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