Why I’m Still Bullish on a Rite Aid Corporation Stock Turnaround
After its acquisition offer from Walgreens Boots Alliance Inc (NASDAQ:WBA) got scrapped and turned into an all-cash deal for a handful of stores, Rite Aid Corporation (NYSE:RAD) was left for dead by investors. The fall from grace was not pretty. RAD stock dropped from nearly $9 to below a $1.50 in less than a year.
That fall doesn’t make much sense.
A few months ago, Walgreens agreed to buy 1,932 stores, or about 43% of the total store base, from Rite Aid for $4.4 billion (and those 43% of stores were the under-performing ones).
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But Rite Aid’s current market cap is less than $2.2 billion. That means that Walgreens paid more than twice as much as Rite Aid’s current market cap for less than half of the company’s revenue-generating assets.
Scratching your head yet? Either Walgreens grossly overpaid for nearly 2,000 under-performing Rite Aid locations, or the market is missing the boat on RAD stock.
I think it is the latter. Here’s why.
Rite Aid Numbers Are Getting Better
Rite Aid just reported quarterly numbers. They weren’t great. Comparable sales are still negative. Margins are still under pressure. Adjusted earnings aren’t trending up in any bullish way.
But the numbers also weren’t all bad.
Comparable sales trends are improving. Front End comps have trended this year from -1.1% to -0.8% to -0.3%. Pharmacy comps have trended from -5.5% to -4.9% to -3.5%. Clearly, there is an upward trend here, and if it continues, Rite Aid will be looking at positive comps soon.
It should continue. Long term comps are cyclical. Comps were up in fiscal 2009, down in 2010 and 2011, up in 2012, down in 2013, up for the next three years and down the next two years. They will likely be down this year, and then up next year. This follows a long-term cycle.
Moreover, reimbursement rates stabilized quarter-over-quarter, and that is big for the margin improvement outlook.
If reimbursement rates can start improving and script counts start to trend up (which is not unlikely because Rite Aid’s store portfolio post-Walgreens deal has a higher mix of remodeled stores, which had significantly higher script growth last quarter than non-wellness stores), margins will start to rebound.
All in all, the numbers are actually showing signs of a near-term inflection point in RAD stock. The turnaround isn’t here yet, but it is coming.
The Rite Aid Business Will Persist
The other overarching concern weighing on RAD stock is that the company won’t be around long enough for its turnaround to materialize.
Why? Amazon.com, Inc. (NASDAQ:AMZN).
But as I’ve pointed out before, Amazon withdrew its pharmacy application in Maine, meaning that either Amazon is scrapping/postponing its whole big pharma plans or that the company is looking for alternative ways to enter the market (i.e. acquisition, and Rite Aid tops the acquisition list given its big reach and discounted price tag).
Either way, the Amazon threat to Rite Aid is minimal at this point in time.
Even if Amazon does bust into the big pharma market without acquiring Rite Aid, the risks to Rite Aid are already priced into the stock price. Because the company is already paying down debt from funds received in the Walgreens deal, Rite Aid’s enterprise value is rapidly dropping. But its EBITDA is eroding at a much slower pace, putting the EV/EBITDA multiple at under 5.
That is a historical low for RAD stock and makes no sense for America’s sixteenth largest retailer.
Bottom Line on RAD Stock
Comparable sales are trending towards positive territory. Margin improvement is on the horizon thanks to an optimized store base and improving reimbursement rate trends. EBTIDA rates should start to improve. Debt is going down.
All of these are positives. And yet, Rite Aid stock trades near an all time low valuation.
I think its time to be greedy when others are fearful. The turnaround may not happen right away, but over time, this stock should head significantly higher and be a big out-performer from these depressed levels.
As of this writing, Luke Lango was long RAD and AMZN.
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