Why Now Is NOT the Time to Sell Rite Aid Corporation Stock

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Thanks to positive progress on tax reform and a huge Black Friday/Cyber Monday shopping weekend, the whole market is in rally mode. This week alone, the S&P 500 has already gained 2%. But one stock that has been an especially big winner is beaten up specialty pharmacy retailer Rite Aid Corporation (NYSE:RAD).

Why Now Is NOT the Time to Sell Rite Aid Corporation (RAD) Stock

RAD stock, which had slumped to 5-year lows after complications turned an acquisition offer from Walgreens Boots Alliance Inc (NASDAQ:WBA) into an all-cash deal for roughly 2,000 stores, is up 24% this week. RAD stock is now trading above $2 for the first time since early in October.

Can this positive momentum be maintained? I think so. The last thing I’m doing here is selling RAD stock on a mini-bounce while it has multiple positive catalysts yet to materialize and still languishes at multi-year lows.

The Recent Rally in RAD Stock Is Well Supported

What is behind the big rally? A few things. Most importantly, Rite Aid is finally starting to transfer ownership of stores to Walgreens. That means cash is starting to come in the door for RAD. That cash will be used to pay down debt. In this sense, the more cash that comes in the door, the more RAD’s debt-related risks are mitigated.

That is big for RAD stock, which has been plagued by over-leverage for multiple years. This leverage reduction should continue to act as a positive tailwind for RAD stock. The last time RAD’s debt-to-EBITDA ratio was dramatically reduced (in 2012-14), RAD stock took off like a rocket ship, shooting from $2 to $8.

But there are also other catalysts behind this rally.

Rite Aid recently added Apple Pay as a payment option for online purchases. This is a sign that the company is successfully adapting to the world of omni-channel retail. Rite Aid is getting rid of a big chunk of its under-performing brick-and-mortar locations while simultaneously boosting its online business. That is a winning strategy in today’s retail world.

There are also rumors floating around that Amazon.com, Inc. (NASDAQ:AMZN) may be interested in buying RAD. I don’t think it is likely. But, given that corporate cash reserves and M&A activity are at record highs, Amazon has a huge interest in the pharmacy space and that Amazon recently acquired Whole Foods Market, Inc. (NASDAQ:WFM) in a deal hardly anyone saw coming, I don’t discount rumors that Amazon is interested in Rite Aid.

After all, such an acquisition would make sense because it would save Amazon the headache of obtaining state pharmacy licenses and implementing the infrastructure necessary for a successful pharmacy business. Acquiring Rite Aid, like acquiring Whole Foods, gives Amazon a foundation to work with.

All in all, between leverage reduction, a boosted online presence, and M&A chatter, it appears as though the best is yet to come with Rite Aid.

Bottom Line on RAD Stock

This is a stock that gone from $2 to $9 before (see 2001). It’s gone from $2 to $6 before (see 2003). It has also gone from $1 to $9 before (see 2012-14). In other words, RAD stock has staged big comebacks before.

I think it can do it again.

If you look at the most recent rally in RAD stock, the drivers were leverage reduction, a depressed valuation and a turnaround in comparable sales growth. It looks like we will get all 3 of those same catalysts again very soon.

The influx of cash from the WBA deal will cause huge leverage reduction. 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).

Consequently, the last thing I’m doing is selling RAD stock here. I think this stock is good for a big rally to $5 or more over the next 12-plus months.

As of this writing, Luke Lango was long RAD and AMZN. 

 


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