I’ve been a strong supporter of Rite Aid Corporation (NYSE:RAD) stock even amid its failed $17.2 billion merger bid with larger rival Walgreens Boots Alliance Inc (NASDAQ:WBA), which caused RAD stock to plunge to all-time lows. And I see no reason to cut bait now.
For several reasons, Rite Aid now has the right prescription to heal the tough wounds investors have suffered over the past several years.
RAS stock has fallen 72% year-to-date and 70% over the past year. This compares to an 8% decline in SPDR S&P Retail (ETF) (NYSEARCA:XRT). The company’s valuation, currently at $2.4 billion, is a fraction of the $8.5 billion it was valued at in January when it had an offer on the table from Walgreens of $6.50 to $7.00 per share.
Where Rite Aid Is Today
Fearing the deal would threaten competition, antitrust regulators dragged their feet, refusing to approve the deal. This is even though both Rite Aid and Walgreens agreed to divest several stores to Fred’s, Inc. (NASDAQ:FRED) to make the deal more palatable. When it seems the Federal Trade Commission’s stance remained “over my dead body,” Walgreens threw its hands up and instead agreed to buy 2,186 of Rite Aid stores for $5.18 billion, which comes with a $325 million merger breakup fee.
This new deal, along with the proceeds, will allow Rite Aid to lower its debt and operating expenses over the next several years, while boosting cash flow. So, purely from a risk-versus-reward perspective, RAD stock — priced at less-than five times book value — can trade at $5 to $6 per share a year from now.
Consider, even in the near-term, there is money to be made. Mizuho analyst Ann Hynes, though she recently downgraded RAD stock from Buy to Neutral, issued a price target of $2.95, suggesting a 27% premium from current levels. In other words, the optimal selling period in Rite Aid has already come and gone. Rite Aid — as a new company — looks better today than it did a year ago.
How RAD Can Heal Itself?
The company, which now trades on the assumption that the company will cease to exist without the full buyout from Walgreens, has many levers it can pull to create value for shareholders. So, it makes more sense to focus on RAD stock’s future prospects and less on what the company used to be. When assessing the potential value in Rite Aid, the company’s $7.2 billion in debt and enterprise value of $9.4 billion stands out.
But here’s the thing: The $5.18 billion Rite Aid stands to receive from Walgreens for 2,186 stores means it would get more than half of its enterprise value in cash. Plus the company stands, thanks to tax loss carryforwards (from net operating loss), won’t have to suffer much in terms of tax payments on the proceeds. Assuming the $5.2 billion is used to pay down debt, the debt burden not only would fall to around $2.5 billion, but it would drastically reduce the interest expense Rite Aid pays on the balance.
The savings from the debt could fuel cash flow, thereby stabilizing the operation. Meanwhile, in addition to the new cash and debt-reduction capabilities, RAD will be left with 2,336 stores that are more profitable and, thus, more appealing to a new buyer such as CVS Health Corp (NYSE:CVS) or possibly Amazon.com, Inc. (NASDAQ:AMZN).
Looking ahead, Rite Aid will report second-quarter earnings next month. Wall Street expects the company to lose a penny per share on revenue of $7.78 billion. This compares to the year-ago quarter when the company earned 3 cents per share on revenue of $8.03 billion. Assuming a bottom-line beat and “less bad” guidance, RAD stock — currently around $2.26 — can spike above $3 within days after the report. Conversely, the stock can fall to $2 or below. But I see less of a chance that will happen, given the already gloomy sentiment surrounding the stock.
Bottom Line for RAD Stock
What the “new Rite Aid” will look like a year from now is still up for debate. But there are signs that the narrative can change for the better. Since falling to a low of $2.21 on July 12, RAD stock has risen as much as much as 25% to $2.77. As such, I see an opportunity here for investors to make some strong gains, especially since there is now evidence that the stock has bottomed, suggesting there is now more buyers than there are sellers.
As of this writing, Richard Saintvilus did not hold a position in any of the aforementioned securities.
