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You Should Buy Rite Aid Corporation Stock Only If This Happens

James Brumley

Rite Aid Corporation (NYSE:RAD) investors certainly haven’t been faced with a shortage of things to chew on of late. Between a (greatly) scaled-back deal to sell some of its stores to rival Walgreens Boots Alliance Inc (NASDAQ:WBA) and reports that Amazon.com, Inc. (NASDAQ:AMZN) was mulling an entry into the prescription drug business, RAD stock news headlines have been plentiful… and mostly bearish.

You Should Buy Rite Aid Corporation (RAD) Stock Only If This Happens

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The failure of Walgreen’s initial plan to outright acquire all shares of RAD stock in 2015 followed by the no-go on 2016’s revised plan to only buy 2,186 Rite Aid units — WBA is now only acquiring 1,932 of Rite Aid’s 4,560 stores — spurred mounds of investor concern, as a large cash infusion was seen as the only way to save the struggling Rite Aid Corporation. Likewise, Amazon’s penchant for eventual dominance in any market it enters, thrusts RAD deeper into a grim light.

Here’s the thing: Rite Aid was in trouble, maybe even doomed, well before Walgreen’s was interested. It was in over its head well before Amazon.com toyed with the idea of selling pharmaceuticals online. Rite Aid has simply allowed itself to get into some low-margin habits, and it’s unlikely to escape even with more money, fewer stores, and with or without its pharmacy benefits management business.

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Crunching the Numbers

Down nearly 80% since January’s high, if you’re asking yourself if you should buy Rite Aid stock, you’re not alone. It is tempting, even though it looks to be a mess right now. To answer this question, though, no, RAD stock isn’t really ownable for the long haul here. The reason? It’s just bad at the drug store business.

While no two companies are ever exactly the same, outfits that operate in the same industry should more or less produce (relative) numbers that look like those of their peers. They are, after all, addressing the same set of consumers under the same constraints against a backdrop of the same opportunities.

To that end, a simple comparison of Rite Aid’s recent trailing-twelve-month-accounting statements to those of CVS Health Corp (NYSE:CVS) and Walgreens Boots Alliance reveals what’s really wrong with RAD stock. Between the cost of the goods it sells and paying its personnel, it’s spending too much for every dollar in revenue it rakes in.

Yes, CVS spends more on what it sells, though it more than offsets that added cost on the selling and administration front. All told, Rite Aid spends nearly 99% of its revenue on the goods it sells and people, whereas neither CVS nor Walgreens Boots Alliance spends more than 95% of its revenue on those income-statement items. The 3% difference may seem insignificant, but in the cutthroat world of retail, where margins are paper thin and every penny counts, that 3% could have kept Rite Aid from getting into trouble by allowing it to invest in its own growth.

Put another way, Rite Aid doesn’t have a regulatory problem. It doesn’t really have a debt problem either, despite plans to use the proceeds from the sale of those 1,932 stores to pay its creditors.

Rite Aid has a retailing problem. It’s simply not offering enough of the right product at the right price in the right way to the right people. That problem, however, may be the toughest of all problems to solve in the world of retailing.

RAD’s Pharmacy Benefits Management (PBM) business is skewing the numbers, though, right? No. Rite Aid’s PBM revenue only accounts for about 20% of its total sales mix and, in terms of EBITDA, it’s sported the same paltry ~3% figure that its retail business has generated over the course of the past couple of years. In other words, Rite Aid’s PBM neither helps nor hurts the quantifiable health of its overall results.

Bottom Line on RAD Stock

Larry Meyers was right earlier this week when he said Rite Aid still might have a chance. The company can be fixed. It could even be fixed without the sale of assets to pay down at least some of its debt.

If Rite Aid is really going to be repaired, though, and if RAD stock is truly going to become investment-worthy again, it’s going to have to do the most obvious and straightforward things first — mainly, compel more customers to come into its stores and make a purchase, the way CVS and Walgreens are.

Anything else, and the company is just buying time.

This will be doubly true if Amazon decides to wade into the drug prescription waters.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter.

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