Analyst: Rite Aid Faces Integration Hurdles

Amid a recent run for Rite Aid shares, a Goldman Sachs analyst warns investors not to forget that little business of an integration

Rite Aid Corp. (RAD)'s stock price has surged in recent months as investors bet on the drugstore chain's turnaround. Goldman Sachs (GS) isn't so sure that collective wisdom is correct. Goldman analyst John Heinbockel is skeptical and downgraded Rite Aid shares to sell from neutral on Jan. 19. He thinks the Camp Hill, Pa.-based company's plan to buy the Brooks and Eckerd drugstore chains from The Jean Coutu Group (PJC) Inc. could bring trouble.

When Rite Aid stockholders overwhelmingly approved the $3.4 billion acquisition on Jan. 18, investors bid up the shares around 1%. But Rite Aid's stock price sank 5.1% the next day to close at $5.83 on the New York Stock Exchange.

"The shares appear to be discounting a near-flawless integration and very few mergers proceed so smoothly," Heinbockel said in a research note.

Rite Aid expects to revamp itself into a 5,000 store powerhouse by adding 337 Brooks stores and 1,521 Eckerd stores on the East Coast and in the Mid-Atlantic states. The company also thinks it will save money by reducing overlap in areas such as merchandising, purchasing, advertising, distribution, and administrative expense.

But Heinbockel pointed out that Rite Aid faces challenges. The company's management will have to navigate tricky customer service issues, like changing the names on Eckerd and Brooks monikers to Rite Aid, which opens the risk of losing customers who liked the old store. Rite Aid has other tasks to deal with too, like converting its information technology system into all the stores. Meanwhile the drugstore has to keep turning its own business around and build a stronger, more customer-oriented culture. Rite Aid, says Heinbockel, faces more challenges than any other company he covers.

Yet Rite Aid's share price has outperformed its drugstore peers since Wal-Mart announced a $4 generics program last fall, roiling the industry. Rite Aid's shares have gained about 33% of their value since, Heinbockel's report said. If prices correct or Rite Aid meets enough of its challenges, he might be more inclined to take a constructive stance on the company then.

(Goldman does and seeks to do business with companies covered in its research reports, but Heinbockel certified that his views are not related to his compensation.)

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