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Tuesday, August 13, 2024

Can Rite Aid Recover?

Last fall, poor ol’ Rite Aid finally succumbed to bankruptcy. It was pretty much the definition of an expected surprise.

To get a comprehensive look at the company’s ever-declining fortunes, DCI rummaged around the compnay's numerous bankruptcy filings. Below, you’ll find our review of Rite Aid’s current financial situation, shrinking store footprint, changing relationship with key wholesaler McKesson, surprisingly optimistic projections, and more.

Drug Channels has been tracking retail pharmacies’ economic and business challenges—and Rite Aid’s troubles—for many years. Consider this article to be an opportunity for some fact-based analysis to replace your schadenfreude.

READ ME

As always, I encourage you to review the original source material for yourself. Here are the two main web sites with information on Rite Aid’s bankruptcy: Fair warning: The Kroll site is quite challenging.

HOW WE GOT HERE

Rite Aid, the industry’s third-largest drugstore chain, has long lagged its pharmacy industry peers. Liabilities from opioid-related lawsuits and a tough retail pharmacy environment—reviewed in 10 Industry Trends Driving the Retail Shakeout—finally caught up with years of mismanagement and bad decisions.

At the time of its bankruptcy filing last October, The Wall Street Journal profiled Rite Aid’s ignominious history: Rite Aid Files for Bankruptcy, Undone by Years of Losses.

Over the years, I have highlighted some of Rite Aid’s misadventures here on Drug Channels. Two choice examples from the archives: WHAT’S NEXT (MAYBE)

To convince its creditors that it will not eventually be liquidated, Rite Aid has been executing on a Rite Aid 2.0 plan.

Here's my summary of the plan's key strategies and financial expectations:

1. Grow its prescription business while maintaining prescription gross margins.

Below you can see Rite Aid’s historical prescription revenues along with its June 2024 forecasts. As you can see, the company expects prescription revenues to decline by nearly $3 billion over the next two years, before beginning to climb again.

[Click to Enlarge]

Rite Aid states that it filled about 125 million prescriptions in its 2024 fiscal year, but will fill 142 million prescriptions in its 2029 fiscal year.

Rite Aid also projects that its gross margin from retail prescriptions will decline slowly, from 19.6% in 2024 to 19.2% by 2029. Its 2024 gross margins from prescription dispensing are comparable to—but slightly lower than—other retail pharmacies. Per Section 11.2.2. of DCI’s 2024 Economic Report on U.S. Pharmacies and Pharmacy Benefit Managers, this average reflects very low gross margins for brand-name prescriptions and much higher margins for generic prescriptions.

Since the strategic “how” has not been spelled out, I am left wondering if these projections are wishful thinking or realistic forecasts.

2. Aggressively shrink its store footprint.

Rite Aid wants to grow its business while following Steve Martin’s timeless advice: Let’s get small.

In 2017, Walgreens secured regulatory approval to acquire 1,932 Rite Aid stores and three distribution centers for $4.4 billion. These stores transitioned from Rite Aid to Walgreens by early 2018. That transaction reduced Rite Aid’s store count from more than 4,400 to 2,550 locations.

From 2018 through 2021, Rite Aid operated about 2,500 stores. During the two years leading up to its bankruptcy, Rite Aid closed about 250 locations.

Since it filed for bankruptcy, however, the company has been swiftly shutting stores. As of early August 2024, its store count has dropped to 1,554. That’s nearly 1,000 fewer stores than the company operated just three years ago. As far as we can tell, the company has not provided a target number of locations as part of its bankruptcy plan.

Keep in mind that its downsizing coincides with the broader shakeout in retail pharmacy. In recent years, the number of U.S. pharmacy locations across all formats has begun trending downward. As you can see below, CVS and Walgreens have also been reducing their store count to reflect changes in the pharmacy market.


There are intriguing ripple effects from Rite Aid’s downsizing. Last week, GoodRx announced that Rite Aid’s store closures would reduce GoodRx's profits by at least $5 million.

3. Reduce debt and generate cash.

Rite Aid has undertaken a number of financial transactions to stabilize the business, including reducing debt, lowering borrowing costs, and taking advantage of sale-leaseback transactions.

It has also been shedding noncore assets. In February 2024, Rite Aid sold its struggling Elixir PBM business to MedImpact Healthcare Systems. In May 2024, it sold part of its Health Dialog business to Carenet Health.

Oddly, the company is still holding onto its Thrifty Ice Cream business. According to Eater: The Coolest Place in LA Is the 50-Year-Old Thrifty Ice Cream Factory.

WHAT ABOUT MCKESSON?

For more than 20 years, McKesson has been Rite Aid’s primary wholesaler. Under their 2014 agreement, McKesson took over the purchasing and distribution of generic pharmaceuticals for Rite Aid. McKesson also began making direct store deliveries of brand-name and generic drugs. In 2018, McKesson and Rite Aid announced a 10-year extension of their agreement, through March 2029. DCI estimates that Rite Aid now accounts for about 3% of McKesson’s U.S. pharmaceutical distribution revenues.

Rite Aid’s downfall illustrates wholesalers’ crucial role in the financial transactions within the drug distribution system. Unlike a third-party logistics company, a wholesaler:
  • Purchases and takes title (legal ownership) to a manufacturer’s product
  • Holds physical inventory in anticipation of selling the products to pharmacies
  • Manages accounts receivable from pharmacies
  • Collects payment from its customers
  • Absorbs credit risk from the manufacturer
Hence, McKesson has shielded brand-name and generic pharmaceutical manufacturers from Rite Aid’s financial woes.

Consequently, McKesson has had to contend with the bankruptcy. For example, almost consurrently with its October 2023 bankruptcy filing, Rite Aid sued McKesson. Rite Aid had alleged that McKesson attempted to terminate Rite Aid’s wholesale supply agreement and collect $700 million owed to the wholesaler.

One week later, the companies resolved the lawsuit by amending certain terms of their supply agreement. Among the revised terms was a requirement that Rite Aid pay McKesson within seven days after receiving pharmaceutical deliveries. However, Rite Aid reports that is still negotiating the terms of a fully amended supply agreement.

McKesson recorded a provision for bad debts of $725 million related to Rite Aid’s bankruptcy for its 2024 fiscal year.

THE FUTURE IS NOW

It’s hard to see how Rite Aid will survive the brutal retail pharmacy environment. Among the challenges it will have to navigate:
  • Overcapacity of retail pharmacy locations in many regions and intense competition for consumers (as shown in the chart above)
  • Growing competition from technology-enabled online pharmacies, including Amazon and numerous venture capital-backed startups
So, hang in there, Rite Aid! But remember: The journey of a thousand miles sometimes ends very, very badly.

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