Despite the S&P 500 falling by nearly 6.5% to start the year, Rite Aid (RAD) stock has fallen just 1.5% in 2016.
What makes this impressive is that RAD stock has a beta of 2.06, meaning it is 106% more volatile than the overall market.
With that said, RAD is holding up so well because of the pending merger with Walgreens Boots Alliance Inc (WBA), and given the details surrounding this merger coupled with the volatility of the market, there is no question that RAD stock is a great investment right now.
What Makes Rite Aid Stock so Appealing?
The bottom line is that RAD stock is trading at $7.72 per share, which is well off WBA’s $9 buy price.
The merger will close later this year, in the third or fourth quarter, giving investors who buy Rite Aid stock right now upside of 16.5%. The only way those gains are not realized is if the merger is somehow blocked by regulators.
The fact that an upside of 16.5% remains in RAD stock illustrates that investors are somewhat worried about backlash from regulators. Much like the FCC blocked AT&T‘s (T) merger with T-Mobile US Inc (TMUS) a few years back, citing unfair competitive advantages and potential job losses, RAD investors believe a similar fate could await the merger.
However, the retail pharmacy space is far more fragmented than industries like nationwide wireless services, which have seen consolidation issues in the past.
Furthermore, the acquisition of RAD does not give WBA an obscene market advantage over CVS Health Corp (CVS).
Back in July of last year, Walgreens and CVS had 8,200 and 7,800 locations, respectively. As a result, WBA and CVS had combined market share of at least 50% in 70 of the top 100 markets. That said, CVS will be getting much larger after acquiring Target Corporation‘s (TGT) 1,660 retail pharmacies, thereby making it much larger than Walgreens.
RAD’s 4,600 stores will make Walgreens far larger than CVS once acquired, but thanks to CVS’s purchase of Target pharmacies, it won’t create a complete juggernaut relative to the entire industry.
Not to mention, Walgreens has already said that it would close 1,000 Rite Aid stores, but that it thinks only 500 store closures will be necessary to complete the merger.
In other words, Walgreens will do what is necessary to make this merger work. If you are a RAD stock owner, this should make you quite encouraged.
Also, let’s not forget the leverage that WBA holds over U.S. regulators, with a substantial percentage of its business created overseas.
Last year Walgreens shocked investors when it decided against a tax inversion that would have cut its annual tax payments in half, saving the company billions of dollars. Perhaps it always had its eyes on RAD, and knew that it needed to keep regulators happy.
It makes sense, because even at $9 a share, WBA is getting a bargain for RAD at just 0.28 times next year’s expected sales. Notably, WBA trades at a much steeper 0.8 times revenue.
What If the Worst Happens?
So more than likely, or almost certainly, RAD will be a part of Walgreens by year’s end. However, let’s assume the absolute worst case scenario: Let’s assume that regulators ignore CVS’s acquisition of TGT pharmacies, and WBA’s plan to close 1,000 stores, and that Walgreens’s tax inversion risk has no influence over regulators.
In that scenario, one might think that RAD stock could fall significantly, maybe losing more than it could possibly gain with the acquisition.
At $7.72, Rite Aid stock is actually trading lower over the last year, and about equal to the levels that it has traded at for most of the last year.
As a result, Rite Aid stock is not really figuring the buyout into its valuation, thereby making RAD even more attractive, and a stock to buy right now.
As of this writing, Brian Nichols owned shares of Rite Aid.
