In October 2015, Walgreens Boots Alliance Inc (NASDAQ:WBA) agreed to acquire Rite Aid Corporation (NYSE:RAD). The deal works out from $6.50 per share to $7 per share, depending on divestitures. So why the heck is RAD stock trading at a measly $3.40?
It’s a very good question and we can start by answering that with information already provided: The date.
It has been a ridiculous 19 months since the companies announced the deal. WBA has said it will divest locations to get the Federal Trade Commission’s blessing. In December 2016, Fred’s, Inc. (NASDAQ:FRED) said it would buy 865 RAD stores.
Now it may be more.
As time goes by without the deal closing, confidence wanes that it will happen. In early May, WBA and Rite Aid made necessary steps that now forces the FTC to make a decision within 60 days. For its part, the FTC still doesn’t seem sold on the deal.
Moving on With Rite Aid
We could write a book about the back-and-forth between the parties involved in this deal. But that’s not the goal here. Instead, it’s to find out what upside could exist.
If the deal were to go through, RAD stock would have upside of about 85% to 100%.
The problem is, the FTC isn’t sure that Fred’s can handle a 1,000 store divestiture. If the deal doesn’t go through, the question becomes, how much is everything worth? WBA of course, would be just fine. The $87.5 billion company would continue humming right along. In fact, shareholders will likely cheer the additional clarity that comes with the news.
The same cannot be said for RAD. Although Rite Aid has done an OK job at growing revenue, the same cannot be said for profits. Net income dropped from $278 million in fiscal 2016 to just $48 million in fiscal 2017.
Revenue grew 6.8% in fiscal 2017 on a 53-week schedule. That’s down from the 15.8% growth it had in 2016 and that figure is forecast to slow even more. Analysts expect just 0.3% growth in fiscal 2018.
For me, the bigger problem is the debt. In the most recent quarter, Rite Aid — which has a $3.67 billion market cap — had $7.33 billion in debt. There’s worse crimes out there, but that’s a lot of debt nonetheless. This is up about 4.8% year-over-year and a whopping 31.8% over the past two years.
Bottom Line on RAD Stock
Ever since WBA said it’s acquiring RAD, Rite Aid’s actual business has been down in the dumps. RAD stock isn’t making it easy, either. Flat earnings and revenue growth over the next two years aren’t anything to cheer about. And the debt picture is certainly a concern, assuming it trends higher, not lower.
In a Rite Aid vs. Walgreens assessment, WBA is an easy winner. First, without the RAD deal, Walgreens can initiate a large buyback or boost its 1.85% dividend yield. With the deal, WBA is quickly expanding its footprint and can drive solid sales growth.
When focusing solely on RAD stock, it’s a bit more dismal. Even at $3.50, it’s not an overwhelmingly compelling buy. Sure, a bounce back to $4 to $5 could be in the cards and make for a great percentage-based return.
But if $3.50 fails to hold, the next significant line of support comes at $2.50. Positively speaking, the MACD momentum (orange circle) looks to be turning positive. But this alone is not reason enough to buy RAD stock.
To be honest, Rite Aid stock isn’t very promising. Some say the odds of an acquisition are below 40%. For those that believe the transaction will go through, perhaps they should consider a few options.
Various bull call spreads between the $4 to $6 strikes have reasonable pricing. For instance, the $4.50/$5.50 August call spread can be bought for about $0.25 ($25). With 78 days until expiration, the August options should capture the FTC’s decision. Keep in mind this is a speculative trade, though.