Rite Aid Corporation (NYSE:RAD) is not going to move too much behind its second-quarter numbers. After all, there is a massive acquisition in play, which thereby minimizes the effect that earnings would normally have on Rite Aid stock.
Maybe that’s a good thing.
According to Walgreens Boots Alliance Inc (NASDAQ:WBA), it will complete its $9 per share purchase of RAD before year’s end. And based on its talks with the Federal Trade Commission, there is no reason to think the two retail pharmacy giants won’t be able to merge as one company. Therefore, no earnings too big or small will have much affect on Rite Aid stock. This is a merger arbitrage play before anything else.
That said, there are things in Rite Aid’s earnings that have become a concern.
The question becomes: What effect might these concerns might have on Rite Aid stock if the merger is blocked? Furthermore, could these concerns affect Walgreens’ desire to even get this merger done?
Rite Aid Stock: What’s So Alarming?
If you look at the headline numbers, Rite Aid earnings look rather impressive, with 4.8% year-over-year growth and revenue of $8.03 billion. However, that’s because Rite Aid acquired a pharmacy benefit management business, EnvisionRX, last year. EnvisionRX had sales of $5 billion in 2015, with rapid growth from the $1.7 billion it achieved in 2011.
Rite Aid’s Pharmacy Services segment continues to grow at an impressive clip, and is making the company’s overall performance look much better than it is. Same-store sales declined 2.5% year-over-year, behind a 3.6% drop in pharmacy sales.
So while the Pharmacy Services segment continues to impress, it’s just not large enough to hide the retail pharmacy side’s struggle. Fact is Rite Aid has taken a huge step back in the performance of its retail business. RAD blames the problem on a challenging reimbursement-rate environment, and while true, both Walgreens and CVS Health Corp (NYSE:CVS) still manage to produce positive comparable-sales growth.
This is what I find so alarming about Rite Aid’s performance.
What If the Walgreen Merger Fails
Looking ahead, there is always that slight risk that the FTC comes back and says, “We don’t care how many stores you close, Walgreens and Rite Aid are not merging.” In retrospect, that risk is why RAD stock still trades at an 11% discount to its buyout price, despite just a few months from the expected close.
If that risk did not exist, Rite Aid stock would be trading much closer to the $9 per share buyout price. That said, the big question that investors should be asking is if the FTC blocks the merger, what would RAD be worth?
Remember: Rite Aid shares traded at $6.30 per share before Walgreens announced the acquisition, and they had fallen from near $9 per share when growth started to decelerate and margins tightened.
Back then, Rite Aid was still a growing business. That’s not the case anymore. Margins have lowered even more and its pharmacy business is in clear decline. If the Walgreens buyout gets blocked by the FTC, I wonder how low RAD stock will fall — $6, $5, maybe even $4 per share?
When you start weighing these risks relative to the 11% upside, Rite Aid stock all of a sudden starts to look like a risk.
As of this writing, Brian Nichols did not hold a position in any of the aforementioned securities.
