Should You Buy Rite Aid Corporation (RAD) Stock? 3 Pros, 3 Cons

Advertisement

The situation at the Rite Aid Corporation (NYSE:RAD) keeps on getting worse. What seemed like a simple merger deal with Walgreens Boots Alliance Inc (NASDAQ:WBA) has turned into a soap opera. RAD stock makes sizable moves up and down with regularity as each new merger rumor causes traders to eagerly swing into action.

Should You Buy Rite Aid Corporation (RAD) Stock? 3 Pros, 3 Cons

However, on net, the majority of traders have been selling RAD stock. It hits increasingly low levels with each passing week. Wednesday’s latest development now has RAD stock plunging below the $4 mark; that’s a new 52-week low.

In fact, it’s a more than three-year low for Rite Aid. Can Walgreens Boots Alliance still pull this deal off and salvage the situation for Rite Aid stockholders? Or will RAD stock continue trending toward zero?

RAD Stock Cons

The Unending Merger Process: Walgreens originally agreed to acquire Rite Aid at the end of 2015. My how time has passed … yet the deal hasn’t closed. Far from it, in fact, Walgreens cut its offer for RAD stock from the initial $9. The updated offer would give shareholders $6.50-$7 per share of RAD stock, depending on how many stores Rite Aid divests to comply with antitrust concerns.

At first, Rite Aid shareholders reacted bitterly to the slashed merger premium. RAD stock had consistently traded above $6.50 in recent quarters, thus the new offer would leave many holders with a loss on their positions. However, as time goes on, that $6.50-$7 offer itself looks increasingly dubious. RAD stock initially settled in the mid-$5’s following the revised deal terms. That suggested a reasonably high probability of the deal closing. However, in recent weeks, shares have tanked again, as the market reflects increasingly uncertainty that shareholders will even get that $6.50 payout.

FTC Lawsuit Coming? The Capitol Forum, a private subscription research shop, suggested Wednesday that the Federal Trade Commission will bring a lawsuit to stop the Walgreens/Rite Aid merger. While Rite Aid is clearly struggling, federal regulators still view the combined entity as potentially too large. Even after divesting 1,000 or more stores to Fred’s, Inc. (NASDAQ:FRED), the combined company would still exert a great deal of market dominance within the American pharmacy sector.

Walgreens has pushed aggressively on the timeline to try to get this deal done. However, that speediness may simply have irritated the FTC and hardened its resolve. Bulls had speculated that the new Donald Trump administration would be more favorable for mergers, though it simply may not play out in this case.

In Trouble If Merger Fails: It’s easy to make a bull case for RAD stock if the merger fails. The stock traded up around $7-$8 prior to the start of the merger talks. Remove the uncertainty and Rite Aid stock recovers sooner or later, right?

Not so fast. Rite Aid’s financial results have deteriorated materially over the past five quarters. Walgreens came in with its bid as Rite Aid’s same-store sales growth rate touched multiyear highs up around 5% year-over-year. However, Rite Aid has struggled; that growth was an aberration, not a new trend. Same-store sales turned negative late last year, and are now several percent into the red. EBITDA is down by more than 10% over the past few quarters as well. For a heavily levered business, even moderate slowdowns really hit the equity hard. Rite Aid today is much weaker than it was when Walgreens made its initial buyout offer.

RAD Stock Pros

Quick Buyout Premium Possibility: The ongoing merger process has been disastrous for long-term RAD stock owners. However, from other people’s pain can come opportunity. RAD stock has fallen from as high as $8.50 earlier this year to just $4 now.

If the merger closes, buyers today make at least 60% on their money, even if the eventual cash consideration is $6.50/share. At $7, the deal would be even sweeter. It’s hard to handicap the odds of the merger closing, particularly with the latest FTC rumors. However, even if the odds of a deal closure are just one-third, that still makes for some interesting math considering you make 60% or more in the event that the merger succeeds. RAD stock isn’t worthless — at least not immediately – if the deal fails, while if it closes you get a large and quick profit.

Overly Negative Sentiment: Investors have punished RAD stock in particular over the past few sessions. The stock has slipped from $4.60 to around $4 over the past few trading days. This is largely on rumors out of Capital Forum. The rumors would be damaging if true, but at this point, we still don’t know. Investors are rushing into action, particularly since the $4 support level broke, setting off a round of technical selling.

However, the Walgreens/Rite Aid story has been full of rumors, not all of which turned out to be true. With the stock off this sharply, it’s set-up for a quick reversal in the event the FTC story is wrong and/or some newer bullish rumor comes along. It’s worth remembering that Walgreens CEO Stefano Pessina stated just two weeks ago that he’s optimistic the deal will close by July. Don’t get too fixated on any latest development; keep looking at the bigger picture and overall risk/reward situation.

Chance if Turnaround if Deal Fails: In the event this merger fails, RAD stock would likely trade down in the short-term. Deutsche Bank, for example, suggested that RAD stock would fall to $2.25 per share if Walgreens can’t close the deal.

However, that short-term hit could lead to a big bounce-back opportunity. Rite Aid isn’t worth the $8 per share it traded for before the merger. However, management would surely be forced into turnaround mode, trying to stem the recent operational declines. The company would likely look for other ways to find shareholder value. And if they didn’t succeed, activist investors would likely step in and try to dump the board. Already, we saw an activist movement to try to vote down the $6.50-$7 merger offer. If RAD stock came out of this trading in the $3’s or lower, you’d almost certainly see some motivated value investors step in here.

Verdict

As RAD stock goes ever-lower, the appeal of a speculative long position grows. Yes, this is a highly risky position. There is a chance Deutsche Bank is correct and this stock gets pounded to the $2’s if the deal fails. The FTC rumors are certainly another negative development.

However, there is a real chance at a quick 60% gain here if Walgreen’s CEO is correct and the deal closes. Even if it doesn’t, activist investors would likely buy up the stock and try to turn the company around. This is a high-risk gamble, but at $4 or less, it’s a reasonably priced one in any case.

At the time of this writing, Ian Bezek owned WBA stock. He had no position in Rite Aid stock. You can reach him on Twitter at @irbezek.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2017/04/should-buy-rite-aid-corporation-rad-stock-pros-cons/.

©2024 InvestorPlace Media, LLC