Since Rite Aid Corporation (NYSE:RAD) stock is down 71% year-to-date, some investors may think a rebound is around the corner. The market isn’t always rational, and sometimes it overreacts. Could this be the case with RAD stock?
The retail sector as a whole isn’t doing too well, with the SPDR S&P Retail (ETF) (NYSEARCA:XRT) down 8% YTD. Investors worry about Amazon.com, Inc. (NASDAQ:AMZN) putting existing brick-and-mortar retailers out of business, and its merger with Whole Foods Market, Inc. (NASDAQ:WFM) won’t allay these fears.
Rite Aid shareholders had hoped to pocket $6.50 to $7.00 per share from the company’s sale to Walgreens Boots Alliance Inc (NASDAQ:WBA). And on June 26, RAD stock shot up 30% on reports that the deal was nearing approval by the Federal Trade Commission.
But then they had their hopes dashed, as Walgreens called off the deal, instead agreeing to buy 2,186 of Rite Aid’s over 4,500 stores and some related properties for $5.18 billion, plus a $325 million merger termination fee.
RAD will use the proceeds of the deal to reduce its heavy debt burden by two-thirds. The deal also should make the company, which currently operates at a loss, profitable again.
Last month, Rite Aid released some pro forma information regarding the asset sale. The new, leaner drugstore chain would be profitable, earning $93 million in the 52 weeks ending on March 4, 2017.
RAD Stock: Valuation
Currently, Rite Aid operates at a loss.
But if we use the above mentioned pro forma figures, RAD stock gets a price-to-earnings multiple of 27.5, which is not bad, but not that cheap.
How does RAD stack up relative to its peers?
You can buy Walgreens stock for 20 times earnings and 14.7 times forward earnings. CVS Health Corp (NYSE:CVS) stock is even cheaper, trading at 16.3 times earnings and 12.3 times forward earnings.
RAD stock now trades at 4.43 times book value, against a multiple of 2.39 for CVS and 2.85 for WBA.
And that’s not all; these two competitors don’t just earn a profit, they also pay dividends. CVS stock yields 2.54% and WBA 1.97%.
Also, the deal will leave Rite Aid much smaller in an industry where size matters. The bigger a drugstore is, the more bargaining power it has with drug wholesalers. More bargaining power means lower costs for the pharmacy.
CVS and WBA dwarf RAD in terms of sales, and this is before it sells half its stores.
Of course, this won’t immediately be a problem for Rite Aid, which will be able to source drugs at low costs from Walgreens for the next 10 years.
I don’t see Rite Aid as a compelling buy relative to its peers. I think there may be bargains in the retail sector, but I would look elsewhere.
EXPR: A Real Retail Bargain?
I looked at retail stocks, and one really stood out: the fashion retailer Express, Inc. (NYSE:EXPR). Now, a chain of drug stores vs. an apparel store might be an apples-to-oranges comparison, but look at its valuation.
You can buy Express stock at a very low price. EXPR stock goes for 12.5 times earnings, 11 times forward earnings, 0.23 times sales, 0.79 times book value and 4.42 times free cash flow.
Of the thousands of stocks traded on public exchanges, this has got to be one of the cheapest. I checked, and you could say it’s among the seven cheapest. I found seven stocks that fit these criteria:
- Price/Earnings Ratio under 15
- Forward Price/Earnings Ratio under 15
- Price/Sales Ratio under 1
- Price/Book Ratio under 1
- Price/Free Cash Flow Ratio under 5
The amazing thing is that even these measures fail to fully capture how cheap EXPR stock really is. Express holds zero debt, and it has a cash position equal to some 40% of its market capitalization.
This gives Express an enterprise value equivalent to about 60% of its market capitalization. Enterprise value, which sets aside a company’s cash balances and debt, is arguably a better way to value the underlying business.
What about Amazon and the shellacking it’s giving retail? Well, Express seems to be making progress in the transition from brick-and-mortar to e-commerce. Online sales jumped 27% in the first quarter of 2017, and now make up 20.9% of EXPR’s revenue.
Investors, scared of Amazon, may be shunning the retail sector. EXPR looks to me like a dirt-cheap retail stock that’s flying under the radar of most investors, and a better buy than Rite Aid stock.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.
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