In the stock market, I have a couple rules I like to follow. One of them is to almost always stay away from stocks trading under $5. After all, there is a reason they are under $5, and its not because things are going well. But every once in a while, one finds a hidden gem among these cheap stocks. I think Rite Aid Corporation (NYSE:RAD) is one of those hidden gems.
I’ve stated my bull thesis on RAD stock before, but I’ll do so here as well.
RAD is a stock that has staged big comebacks before ($2 to $9 in 2001, $2 to $6 in 2003 and $1 to $9 in 2012-14), so this is a stock that does go down, but normally doesn’t stay down. The drivers of the most recent comeback in 2012-14 were leverage reduction, a depressed valuation and a turnaround in comparable sales growth.
RAD stock is set to benefit from all 3 of those same drivers soon.
An influx of cash from a huge deal with Walgreens Boots Alliance Inc (NASDAQ:WBA) will go towards paying down a ton of debt, resulting in sizable leverage reduction soon. The EV/EBITDA multiple on RAD stock is just over 7 — exactly where it was back in 2013. Meanwhile, comparable sales growth will likely go from negative to positive soon, because comp growth at RAD is cyclical (comps were up in fiscal 2009, down in 2010 and 2011, up in 2012, down in 2013, up for the next 3 years and down the next 2 years).
It might be tough to keep holding onto this bull thesis as RAD fails to trade above $2. But now is not the time to give up hope. I’m actually more bullish on RAD stock now than ever before.
Why? Amazon.com, Inc. (NASDAQ:AMZN).
How Amazon’s Recent Actions Benefit RAD Stock
Amazon appears to have canceled a pharmaceutical wholesaler application in the state of Maine, according to analysts from RBC Capital Markets.
No matter which way you look at it, this is a positive for RAD stock.
Either Amazon is not getting into the pharma business any time soon or it is exploring alternative ways to jump into the pharma business. Either way, RAD is a winner.
If Amazon isn’t getting into the pharma business any time soon, then that means Amazon isn’t going to eat Rite Aid’s lunch any time soon. This is critical, because one of the major headwinds compressing RAD’s valuation is the fear that Amazon will not only enter, but dominate, the entire pharma industry (much like retail).
As this fear gradually fades, RAD stock’s valuation should normalize.
If Amazon is exploring alternative ways to jump into the pharma business, then that implies that Amazon is looking to acquire licenses via a buyout, as opposed to going through the lengthy process of applying for licenses. The most obvious acquisition target in this space is Rite Aid, which is significantly cheaper than peers Walgreens and CVS Health Corp (NYSE:CVS), but also operates in every major state.
Thus, AMZN could acquire a whole bunch of licenses and a pretty strong brick-and-mortar footprint — RAD just sold-off all its under-performing stores to WBA — for a very reasonable price.
Bottom Line on RAD Stock
I normally don’t like stocks under $5, let alone ones under $2.
But RAD stock feels very different to me. This stock has propensity for big comebacks and with leverage reduction and a potential buyout on the horizon, it certainly feels like another big comeback is about to unfold.
As of this writing, Luke Lango was long RAD and AMZN.
