Rite Aid’s dramatic drop in share price in the early 2000s caused it to be removed from index funds and the company has since earned junk ratings for its more than six billion dollars of debt. Rite Aid has significant interest payment obligations, which we believe have severely limited the company’s ability to invest in its store base, leading to lower sales per square foot than its competitors Walgreens and CVS and loss of market share for prescriptions.
Accounting Scandal Sinks Stock
Rite Aid’s long period of decline began on the heels of a major accounting scandal that came to light in October of 1999. In July 2000, Rite Aid’s management completed a restatement of its earnings that showed that the company’s profits had been inflated by $1.6 billion from 1997 to 1999, which was the largest corporate fraud in U.S. history at that time. Five former senior executives went to jail, including former CEO Martin Grass, who pleaded guilty to charges of conspiracy to defraud and conspiracy to obstruct justice. The company’s stock went from a high of more than $50 in the late 1990s to around $2 after the extent of the fraud became known.
Brooks Eckerd Acquisition Saddles Company with Debt
But even after new management cleaned up the books and stabilized Rite Aid’s finances, in 2007 that same management team took the company in a highly leveraged and risky direction when it acquired 1,850 stores in the Brooks and Eckerd drug chains. This acquisition resulted in a debt to equity ratio of 3.5x and added more than $2 billion to Rite Aid’s long term debt load. Soon after the deal, the total value of Rite Aid’s equity turned negative because of a $1.8 billion goodwill write-off required by the poor performance of its share price, which went from above $6 in mid-2007 to less than $1 by late-2008.
Ongoing Challenges Hinder Turnaround
Today, Rite Aid’s main competitors are growing while the company closes stores. Last year management revealed that two-thirds of its stores account for 90% of operating profit and that the other third, or about 1,700 stores, perform poorly and drag down profitability. In recent years, the company has introduced sales initiatives that have since been abandoned, such as a widely advertised guarantee to fill prescriptions in fewer than fifteen minutes and a partnership with discount food retailer Sav-A-Lot. Management is trying to put Rite Aid back in the black, but we believe questions remain about whether the company is headed in the right direction.