I love deep value plays. The best investments I’ve ever made are seeing stocks at ridiculous prices, knowing they are worth far more, and buying at extreme lows. They lead to multi-baggers. Deep value plays are one strategy I employ in my stock advisory newsletter, The Liberty Portfolio. I’m not sure, but Rite Aid Corporation (NYSE:RAD), and therefore RAD stock, may be a deep value play.
The potential downside of this approach is that it can lead to investing in value traps — stocks that look like values but aren’t.
The bearish case for Rite Aid stock has several good arguments.
Is RAD Stock a Trap?
First, as a going concern, RAD stock not only has to deal with brick-and-mortar competition, but also competition from Amazon.com, Inc. (NASDAQ:AMZN). The problem I see with all brick-and-mortar pharmacies is that anything one can buy into the stores can be purchased online. That means it will be easier to buy online, and probably cheaper.
The only time I go to a pharmacy is because it essentially functions as a cheaper convenience store. Obviously, I am not the same as all consumers, since pharmacies do tens of billions in revenues every year. However, from a conceptual standpoint, I think the trend for shopping in these stores is more likely headed down than up.
Yes, the pharmacy business is still a critical part of Rite Aid stores. However, the brick-and-mortar pharmacy is in need of disruption. I don’t know about anyone else, but the lines at pharmacies are ridiculous. The pharmacists spend way more time processing requests and filling out paperwork and typing on computers. Then you have to come back to pick up your order. That’s another area that Amazon may be looking to compete in.
Of course, RAD stock is loaded with debt despite the upcoming sale of stores. Management has never had incentives to grow the business, only to sell it. They don’t care about improving operations.
All this, however, also suggests the bullish case for Rite Aid stock, for the aggressive value player or speculator. That is to say, a possible sale of parts or the whole will likely fetch more than the current value of $2.27 per share.
Cerberus Capital already expressed interest in buying a bunch of Rite Aid stores. Private equity makes a lot of sense because of the way private equity works. These shops generally like distressed assets like Rite Aid stock. The assets are often distressed due to poor management.
Private equity buys the asset, moves in and totally reorganizes the company, so it can be profitable and cash flow. They are often spun out again in an IPO. Sources tells me this is what is happening at 99 Cent Stores, for example.
Bottom Line on Rite Aid
RAD is ripe for this arrangement. It would certainly occur at a higher price, because the company lags all competitors on virtually every metric. A private equity shop would look at what they could squeeze out of a re-organized company and value it at margins it would expect to earn. Moreover, sales of Rite Aid stores will probably allow it to pay off about 70% of its debt, freeing up more than $300 million in cash flow.
Also, if you look at where RAD stock was trading during the speculation over its called-off merger, prices were in the $6 to $7 range.
Things could go either way. With Rite Aid stock at $2.27, there is little downside. Sure, it could go to zero, but with the debt load about to be significantly reduced, that seems increasingly unlikely since the company should go cash flow positive.
I would not invest in RAD stock. However, I think it may be an aggressive speculator’s play.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
