Ever since the proposed acquisition of Rite Aid Corporation (NYSE:RAD) by Walgreens Boots Alliance Inc (NASDAQ:WBA) was restructured multiple times and eventually turned into an all-cash deal for a couple stores, RAD stock has been left for dead.
When Walgreens announced its intention to buy Rite Aid for $9.4 billion in October 2015, RAD stock was trading around $8 and darn close to decade highs. Now, RAD stock price is just $1.50. That is near a decade low (excluding 2008-09).
In about two years, then, RAD stock has essentially gone from decade highs to decade lows.
I think this sell-off is overdone. A scrapped acquisition won’t be the catalyst that bankrupted 55-year-old Rite Aid.
While there is no clear catalyst for a rebound either, RAD stock certainly looks like a bargain at these levels. I’m accumulating shares under the thesis that this is a “short-term pain, long-term gain” story.
The Amazon Threat Is Overblown
Alongside the WBA saga, there has been plenty of other negative news that has weighed on RAD stock.
Among the biggest negative headlines is that Amazon.com, Inc. (NASDAQ:AMZN) is starting to get serious about its incursion into the pharmacy market. That has really been weighing on RAD stock. In the stock market, the one thing investors fear most is competition with Amazon. Look at what happened to retail stocks and, then, grocery stocks.
Pharmacy stocks are meeting a similar fate.
But Amazon’s incursion into the pharmacy market doesn’t spell the end for RAD stock. Amazon will certainly eat market share, like the company has done in the retail and grocery markets. But Amazon won’t entirely kill Rite Aid’s business. Macy’s Inc (NYSE:M), Nordstrom Inc. (NYSE:JWN), Kohl’s Corporation (NYSE:KSS), Kroger Co (NYSE:KR), and Sprouts Farmers Market Inc (NASDAQ:SFM) are all still around.
In fact, Nordstrom is posting positive comparable sales growth, while Kohl’s comps are improving and will likely turn positive soon. Sprouts just reported a really strong beat-and-raise quarter wherein comps rose almost 5%.
So while the Amazon threat is real, it’s overdone. RAD stock will survive competition from Amazon.
This Feels Like a Bottom for RAD
RAD stock is at a valuation bottom by my math.
RAD has about $7.1 billion in long-term debt. That will go down to $2.8 billion after the company uses $4.3 billion of the $4.7 billion it received from WBA to pay down debt. Cash stands around $240 million. Therefore, post-WBA deal, RAD’s net debt will be around $2.6 billion.
Add that $2.6 billion back to a $1.6 billion market cap, and you get an enterprise value of $4.2 billion. Pro forma adjusted EBITDA over the past 12 months is $674 million. That means RAD stock is trading at just 6.2 times trailing EBITDA.
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. Comps were negative. Leverage was big. The story was unwinding.
Sound familiar? It is nearly identical to the situation we have today with RAD stock.
But then comps rebounded, as they always do. Look at the multi-year trend. Comps were up in fiscal 2009, down in 2010 and 2011, up in 2012, down in 2013, up for the next 3 years, down last year, and down again this year. RAD is due for a rebound in comps.
Leverage also decreased. The debt-to-EBITDA ratio shrank from 11 to 5 during RAD’s last big run higher. With the influx of cash from WBA, we will see a similar leverage reduction soon.
The rebound in comps plus the reduction in leverage led to a huge RAD stock rally. By mid-2014, RAD was an $8 stock.
Bottom Line on RAD Stock
The Amazon threat is overblown. Just like Nordstrom, Kohl’s, and Sprouts, Rite Aid will survive an Amazon incursion.
Meanwhile, comparable sales are cyclical (they go from up, to down, to up in a multi-year window) and if this cycle continues, comps will turn positive in the near future. Leverage is also about be reduced by a whole bunch.
Positive comps plus reduced leverage is what caused RAD stock to explode higher in 2013-14. I expect a similar rally to take place soon.
As of this writing, Luke Lango was long RAD, AMZN, and KSS.
