Go Ahead, Be Dumb. Buy Rite Aid

by Lawrence Meyers | July 11, 2013 9:00 am

There are dumb investments, and then there are really dumb investments.

Most of us have made a bad investment here or there over the years. Personally, I can think of more than one dot-com stock from 1999 that has “short-term capital loss” associated with my tax filings. In that case, though, I messed up on momentum stocks.

Another type of dumb investment: value traps — stocks they look like they might be value play but … well … aren’t.

And one really dumb pick that falls into that category: Rite Aid (RAD[1]). Heck, when a friend said he was investing in the pharmacy chain, I told him straight up: “That’s not a value play, that’s just dumb.”

I also told my friend that I don’t need to go past the financials to prove why Rite Aid is a bad place for your money … but I’ll dive a little deeper for you guys.

First, however, we have to start with the company’s balance sheet. Rite Aid has $6 billion in debt that the company is paying $515 million in interest on every year. Oh … wait. It actually just refinanced $810 million of 9.5% Senior Notes due 2017 to 6.75% due 2021. That’ll save a whopping $22 million a year in interest.

Plus, the company turned a $107 million profit last year — its first full-year profit in over half a decade — after losing almost a billion dollars in the previous two years.

Heck, things are going so well at the company that its primary shareholder, The Jean Coutiu Group cut it’s stake by 158 million shares since April of 2012 … at prices between $1.50 and $2.75. That’s a vote of confidence.

Can you smell the sarcasm?

This is all reflective of a business model that just won’t work anymore, at least in part because Amazon (AMZN[2]) is now eating everyone’s lunch. Anything you want to buy at this point is available online … and that includes medications.

There’s nothing you can get in a drugstore that you can’t get elsewhere, and the attempt to move into food and groceries isn’t going to help. In fact, I think it’ll make things worse. You can’t just throw open the grocery aisles in a drugstore. It takes specific types of labor to do food handling and storage. It also requires additional electricity for refrigerated products, which boosts expenses.

Drugstores are really no more than convenience stores at this point, but they are not making the kinds of margins convenience stores make. The latter is able to inflate prices because of the — you guessed it — convenience offered. Drugstores aren’t inflating prices and if they did, they’d lose market share. In addition, much of what you can find at a drugstore can be found at the dollar outlets like Dollar Tree (DLTR[3]) — a company that’s actually growing at 15% annually.

Sure, you can think of Rite-Aid as a potential turnaround play. But also think about this: Execution will have to be perfect, and the company will have to come up with some kind of amazing strategy to push back on all the outside competition — not to mention competition from stores in its own sector, like CVS Caremark (CVS[4]) and Walgreens (WAG[5]).

At a minimum, it will take years and years for any real turnaround to occur … and that’s if it does at all.

Wouldn’t you rather put your money into a stock that’s merely undervalued because the market hasn’t noticed it yet, while it’s growing rapidly and throwing off tons of free cash flow?

I know I would.

As of this writing, Lawrence Meyers was long DLTR.

Endnotes:
  1. RAD: http://studio-5.financialcontent.com/investplace/quote?Symbol=RAD
  2. AMZN: http://studio-5.financialcontent.com/investplace/quote?Symbol=AMZN
  3. DLTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=DLTR
  4. CVS: http://studio-5.financialcontent.com/investplace/quote?Symbol=CVS
  5. WAG: http://studio-5.financialcontent.com/investplace/quote?Symbol=WAG

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