With all the activity surrounding Rite Aid Corporation (NYSE:RAD), the elephant in the room is whether or not investors should buy RAD stock or not. The answer is that I wouldn’t buy RAD stock as an investment, but I would buy it as a speculative trade with substantial possible upside.
RAD stock news has been driven lately by the sale of a bunch of its stores. The FTC approved the sale of a whopping 1,932 stores and three distribution centers to competitor Walgreens Boots Alliance (NYSE:WBA) for $4.375 billion in cold cash.
What we know is that Rite Aid is not a company that is being positioned for growth and certainly not for a turnaround. There is only one arguable direction for Rite Aid now and that is a sale. Management sure isn’t hanging around waiting for some massive turnaround effort to send shares higher.
So the question is whether investors want to get involved with the stock at $1.78 per share and market cap of $1.87 billion.
Frankly, I don’t see why the stock fell from around $2.70 after the deal was announced, since it meant 254 stores fewer got sold than expected. That 10% difference, or about $750 million, should not have mattered so much.
Now, Walgreens can terminate the deal if Rite Aid sells 50% or more of itself to a third party. Yet were that to happen, those stores would likely end up getting sold to another third party or that specific buyer itself.
In the meantime, RAD stock news has centered around the remaining value in the 2,591 stores it currently still owns. Because we know Walgreens offered $4.375 billion for 1,932 stores, we can assume the market value per store is $2.26 million. Thus, the remaining stores alone are worth $5.87 billion.
Rite Aid has a pharmacy benefit management operation called EnvisionRX. It was purchased for $2.1 billion just two years ago and PBM’s tend to hold their value in this health care market. Thus, I put a rough estimate of Rite Aid’s total value at just under $8 billion. Add in the $4.375 billion in cash from the store sales, and assets come to $12.375 billion.
Then we must back out $7.3 billion in long-term Rite Aid debt, which brings our final asset total to $5.075 billion. We divide by 1.05 billion shares and find a reasonable price per share of $4.83. To be conservative, I would knock 10% of that share price to end with $4.35.
That’s a potential of 144% return from here.
The important element of the store sales is that the cash pile that Rite Aid received is likely going to pay down that debt load. In turn, that means RAD stock news will be further driven by the reduced debt service. At an average of about 6.2% annually, it means RAD stock news will be highlighted with an improvement in cash flow of about $275 million annually.
Bottom Line on RAD Stock
With TTM FCF currently at about $190 million, and capex being stalled because Rite Aid doesn’t want to throw money at stores unless it has to, that will boost FCF up to $465 million annually. That in turn will lead to paying down debt even more, since the cash flow isn’t going to be used to expand!
This will make RAD increasingly interesting to private equity shops and other potential suitors, in whole or in part.
Should I buy Rite Aid stock? I think RAD is a speculative buy here at $1.78 and there’s very little downside here. Alternatively, the chance for a big move up to over $4 per share is very possible.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He owns RAD stock and RAD January 2019 $2 calls. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at [email protected].