There is no question that Rite Aid Corporation (NYSE:RAD) stock has been a loser. Continued restructuring of its deal with Walgreens Boots Alliance Inc (NASDAQ:WBA) has left RAD stock beaten and bruised.
An ugly second-quarter earnings report that showed negative comps and margin compression didn’t help. RAD stock now sits just above $2, which is its lowest level since 2013.
I think it’s time to get bullish, as it looks like RAD stock has found a valuation bottom. Plus, financial metrics should start to improve thanks to a cyclical upturn and a more profitable pro forma store base.
All in all, a multiyear valuation low coupled with decent growth prospects makes RAD stock look compelling here.
Rite Aid Stock Has Found a Valuation Bottom
My analysis indicates that Rite Aid stock may have found a valuation bottom here, implying mitigated valuation risk.
Here’s the math.
Currently, the company has about $7.1 billion in long-term debt. Roughly $4.3 billion of the $4.7 billion RAD will receive from the WBA deal will go toward paying down that debt. That means the debt load will be reduced from $7.1 billion to a much more manageable $2.8 billion. There is still around $240 million in cash on the balance sheet, so net debt post-WBA deal will stand around $2.6 billion.
Add that $2.6 billion back to the current market cap of $2.2 billion. You get an enterprise value of roughly $4.8 billion. Pro forma adjusted EBITDA over the past 12 months is $674 million. That means RAD stock is trading around 7.1x trailing EBITDA, using pro forma metrics.
Historically, 7 to 8x trailing EBITDA is a valuation bottom for this stock.
According to YCharts, the last (and only) time the EBITDA multiple was this low over the past decade was in mid-2013. At that time, the EBITDA multiple was hovering around 7.5x, while RAD stock was languishing in the $2 range.
Sound similar? It is nearly the identical situation we have today with RAD stock.
From that mid-2013 valuation low, the valuation proceeded to expand, and the stock proceeded to rally. By mid-2014, RAD was an $8 stock trading around 12.5x trailing EBITDA.
Can Rite Aid Stock Explode Higher Like It Did in 2013-14?
The big question then becomes: Can RAD stock do it again?
I think it can.
It’s important to understand that comparable sales growth at Rite Aid is cyclical. Just look at the multi-year trend since the recession. Comps were up in fiscal 2009, down in 2010 and 2011, up in 2012, down in 2013, up for the next 3 years, and then down this past year. Comps are trending down again this year.
If history tells us anything, it’s that comparable sales growth should turn positive next year. When comps go from negative to positive, RAD stock tends to rally. This is exactly what happened during the big rally from mid-2013 to mid-2014. Comps went from down to up, and RAD stock went from loser to winner.
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The same thing will happen sometime soon because Rite Aid comps are cyclical, and we are about to enter an up-cycle.
Plus, profit margins should move dramatically higher over the next several quarters, and interest expense will fall due to the reduced debt load. Drug costs will fall due to the 10-year option to purchase generic drugs that are sourced through an affiliate of WBA.
And store profit margins should climb higher because RAD’s pro forma store base consists of higher-profit stores concentrated on the West Coast and in the Northeast.
Bottom Line on RAD Stock
Here are the two main reasons to buy RAD stock:
- The stock has found a valuation bottom at 7x trailing EBITDA.
- Comps are due for a cyclical upturn soon, and that plus lower drugs costs should drive decent EBITDA growth next year.
Mitigated valuation risk coupled with decent growth prospects makes RAD stock a compelling value buy here.
As of this writing, Luke Lango was long RAD.
