Rite Aid Corporation (NYSE:RAD) has been a dumpster fire. Its buyout agreement with Walgreens Boots Alliance Inc (NYSE:WBA) took almost two years to fall apart, when it finally came to an end in June 2017. Confidence had clearly been waning in RAD stock, which is down roughly 70% on the year, but today, the stock is up more than 5%.
So what should investors do now? Surprisingly, as much I don’t really like Rite Aid as a company, there is an opportunity to get long for bullish investors.
After Walgreens walked away from its buyout deal with Rite Aid, it immediately came back with a second offer. WBA paid the $325 million breakup fee, then offered to buy just less than half of Rite Aid’s current locations for $5.175 billion.
Why Is This Good for Rite Aid?
Without a deal, it wouldn’t be surprising to see RAD stock filing for bankruptcy protection not unlike what RadioShack was forced to do. When you look at the balance sheet and income statement, it doesn’t take a rocket scientist to figure out why.
While RAD has been able to grow revenue at a reasonable rate — particularly for a bricks-and-mortar business — hardly any of it finds its way to the bottom line. As of last quarter, total debt had grown about 4% year-over-year to $7.24 billion. 4% growth in debt isn’t bad per se, but it’s certainly not good in RAD’s position. That $7.24 billion debt positions looks rather precarious with Rite Aid carrying an equity value of just $2.6 billion.
That’s obviously a big concern for any investor looking into the fundamentals. But we took a deeper look into how the most recent WBA deal could work in Rite Aid’s favor. Initially, it seemed as though Rite Aid stock investors felt fleeced in the new deal. The stock didn’t react favorably, either.
But management told us that it would be left with some prime locations, having many of its best-performing stores remaining. This includes locations all along the West Coast and in states like Michigan, Pennsylvania, New Jersey and Ohio. Breakup fee included, RAD is looking at bringing in about $5.5 billion in the deal with Walgreens.
That is a plentiful amount that can go towards paying down debt (important) and renovating stores, which will hopefully result in higher sales. The reduced store count will also result in lower overhead, helping to ease the SG&A burden on its income statement.
Moving Forward on RAD Stock
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Improvements to the stores and shedding of underperforming locations should also increase RAD’s margins and same-store sales.
Lower debt, better margins, improved same-store sales and hopefully profitability will be in the not-so-distant future.
However, we have to plan for the worst when it comes to RAD stock. Should this deal fail to come to fruition, Rite Aid will likely to need to work through its own restructuring — either now or sometime in the relatively soon future. This deal with Walgreens, in essence, is a highly favorable restructuring. There’s a reason RAD stock trades for less than $3 and it’s not because it’s of high quality.
However, the $2.20-level has acted as strong support to the stock. Should investors want to bet on Rite Aid stock and its eventual turnaround efforts, they can take a shot near current levels. To limit their risk, investors can use a stop below recent lows. If triggered, a loss of about 7.5% would be logged. While bad, it’s far better than a 50% to 100% loss that could occur should things not go RAD’s way with no stop-loss in place.
If the WBA-RAD deal goes through, it could give Rite Aid a clear path to success going forward. Whether that path emerges and whether the company can stay on it remains to be seen, though.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, he did not hold a position in any of the aforementioned securities.
