Why Rite Aid Corporation (RAD) Stock Isn’t a “Bargain Trade”

Earlier in March, when it looked like Walgreens Boots Alliance Inc (NASDAQ:WBA) may not be allowed to acquire Rite Aid Corporation (NYSE:RAD) after all, RAD stock took a hit … a big one. All told, Rite Aid stock is still down 16% for the month, and down a whopping 41% just since the end of 2016. All of that weakness ultimately stems from the distinct possibility its merger plans are apt to be upended.

Why Rite Aid Corporation (RAD) Stock Isn't a "Bargain Trade"

And yet, with that giant-sized pullback, an interesting question has surfaced — is RAD stock a buy with or without the Walgreens buyout based simply based on its stunningly low price?

Investors have certainly justified crazier trades than that.

RAD Stock Below Offer Price

Just for the record, if you’re compelled to step into a position in RAD stock at its current price of $4.89, you’re not crazy. Walgreens’ most recent firm offer is somewhere between $6.50 and $7.00 per share, depending on how many stores it has to sell to appease the antitrust hawks.

There are two potential pitfalls to the strategy, though.

One of the key risks to such a trade is simply that the final purchase price per share isn’t etched in stone.

You may recall the initial offer price was $9.00 per share. That figure has drifted lower in the meantime, reflecting a combination of the ongoing deterioration of the drug store chain’s business and the increase in the number of stores the duo would need to shed to appease the Federal Trade Commission. The latest chapter in the saga indicates the lower offer price based on the sale of 825 units. As the number of stores on the chopping block grows though, the per-share buyout offer sinks.

The other risk? The biggest risk is that a deal doesn’t get done, in which case the value of Rite Aid stock will rest entirely on the company’s laurels. That’s a problem simply because there haven’t been many laurels to speak lately. Still, near a two-year low, surely the worst-case scenario already has to be baked in.

Then again, maybe it doesn’t.

Rite Aid Is a Sub-Par Performer on Own

As compelling as a speculation may be here at an uber-low price for RAD stock, it’s ultimately a bad bet for one key reason. That is, Rite Aid is a habitual loser in the pharmacy game.

The graphics below compare the operating and net margins of Rite Aid, Walgreens Boots Alliance and CVS Health Corp (NYSE:CVS). Although Rite Aid’s gross margins are relatively healthy, the company is alarmingly disappointing when it comes to its net profits.

RAD stock Gross MarginsRAD stock Net Margins

The persistence of the underperformance indicates systemic trouble that’s tough (if not impossible) to solve.

The reason for Rite Aid stock’s perpetual weakness isn’t entirely clear, and to the extent it is clear, it’s difficult to quantify or qualify. The short explanation is, however, it doesn’t run its operation as efficiently as its peers run theirs, and it’s arguably not getting enough traction with its small-scale pharmacy benefits manager EnvisionRx … a business its peers and rivals enjoy much greater scale in.

Regardless of the reason, it’s proving to be a major drag on Rite Aid’s bottom line. A graceful, pain-free turnaround doesn’t appear to be in the cards.

Bottom Line for Rite Aid Stock

The point is, bargain hunters are taking a big risk here if they’re looking to scoop up a stock they think is poised to pop no matter what happens. The only viable ‘out’ for Rite Aid is an acquisition — an acquisition that doesn’t require the sale of more than 1,200 or so stores. Anything more than that, and the plausible price Walgreens Boots Alliance is willing to pay just slumps too much.

To be clear, the stores that Walgreens ultimately intends to cull rather than garner will still be owned by RAD stock holders who somehow, sometime will be able to enjoy their value. That’s far from the optimal outcome though.

Walgreens was willing to pay a premium for the whole Rite Aid network, arguably overpaying for the units they didn’t really want. Another buyer, like Fred’s, Inc. (NASDAQ:FRED), may not be as generous.

In other words, taking a shot on Rite Aid stock is a binary event, and not one worth the risk.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2017/03/rite-aid-corporation-rad-stock-isnt-bargain-trade/.

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