Why Rite Aid Stock Will Probably Underperform Alternatives

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There’s an intriguing case for Rite Aid (NYSE:RAD) stock at the moment. For a long time, bulls  have been awaiting a turnaround that can boost Rite Aid stock, and a new CEO has finally come on board. Meanwhile, with the RAD stock price down over 95% from its early 2017 highs, the stock’s valuation seems like it should be reasonable.

Consider the Alternatives to RAD Stock
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And there is an intriguing, albeit high-risk, positive case for RAD stock at these levels.

The current RAD stock price of $7.50 indicates a market cap of just under $400 million. The company’s net debt (adjusted for the pending sale of two distribution centers) is over $3.2 billion. If the company’s  enterprise value of roughly $3.6 billion rises by just 10%, Rite Aid stock will almost double.

But I’ve  been a longtime bear on RAD stock for reasons that go to the heart of the current bull case. The easy bull argument is that former CEO John Standley ran Rite Aid into the ground. Certainly, the revised deal with Walgreens (NASDAQ:WBA) was a massive disappointment. But the pressures on Rite Aid are the same pressures facing the rest of the industry.

And so it’s a bit too simplistic to believe that a new CEO can simply “fix” Rite Aid all that quickly amid the pressures on the sector. Meanwhile, the company’s  debt creates a major risk to Rite Aid stock going forward. Much like General Electric (NYSE:GE), a popular turnaround pick, new leadership can help RAD stock. But there are significant obstacles that add risk to the company’s outlook.

Moreover, there are other ways, besides buying RAD stock, to bet on the turnaround of the sector. At the very least, those who are bullish on RAD stock should consider those options.

Not Just Rite Aid’s Problem

It’s important to put the performance of Rite Aid stock in the context of the pharmacy space. The entire industry is struggling right now. Fred’s (NASDAQ:FRED), which was going to buy Rite Aid stores as part of the original Walgreens takeover, just filed for bankruptcy. Walgreens stock touched a five-year low last month. CVS Health (NYSE:CVS) bounced off its lowest levels in six years this spring.

The RAD stock price has fallen further than other pharmacy equities. But that’s because Rite Aid has more debt than its peers.

In fact, since the beginning of 2018, Rite Aid stock has fallen 81%. But its enterprise value (its market cap plus the face value of its debt) is down only 22%. Over the same period, Walgreens’ EV has dropped almost 20%, but its shares are down only 24%.

It’s clear that the entire sector is struggling with pressures. Reimbursement rates from insurance companies are falling.  And sales of OTC products, perhaps due to competition from the likes of Amazon.com (NASDAQ:AMZN), remain weak.

Those pressures, combined with higher fixed costs, have dragged down the sector’s profits. Indeed, the operating profit of  Walgreens’ U.S. pharmacy business fell in the third quarter.

Should Investors Buy CVS or Walgreens Instead of Rite Aid Stock?

For RAD stock to finally rally, those industry pressures have to ease. But if that happens, investors can benefit by buying CVS or Walgreens instead. In terms of EV/EBITDA, Rite Aid stock is only modestly cheaper than CVS and Walgreens. As a result, investors would likely be better off buying one of the larger companies, which are big enough to muddle through if the environment doesn’t improve.

In an uber-bullish scenario, Rite Aid stock will no doubt outperform its peers (as it did after the financial crisis). That’s because not many shares of RAD stock are available,  so Rite Aid stock price can jump tremendously if its EBITDA increases and its free cash flow and net income move into the black from their current stagnation.

But if the sector remains stable, Rite Aid stock will likely continue to underperform. And with $3 billion in debt due in 2023, and the company’s net debt over six times its annual EBITDA, RAD may not be able to refinance.

Rite Aid stock will outperform  in a bullish scenario if the industry’s pressures finally ease. In any other environment, Walgreens or CVS will likely do better. So investors who want to bet on the industry have to at least consider buying the shares of those larger operators instead.

What Level Does the RAD Stock Price Need to Reach to Outperform Rite Aid’s Bonds?

There’s another option to consider: Rite Aid’s bonds. Like the RAD stock price, the prices of Rite Aid’s bonds  are at multi-year lows.

The 6.125% bonds that mature in April 2023 have a current price of 79 and an annual yield to maturity of 13.7%. Longer-dated issues are potentially more attractive. The 7.7% February 2027 bonds are priced at 50, with a YTM of 21.2%.The  6.875% bonds that mature in 2028 have a similar price, with a yield to maturity  of 18%.

The bonds are less risky than Rite Aid stock, since secured bonds  may have some value even if RAD goes bankrupt.

And it’s important to realize that RAD stock needs to climb substantially just to outperform those bonds. To top the April 2023 bonds, RAD stock price would need to reach $12. To beat the 2027 bonds, the RAD stock price would need to soar over 320%.

The bond prices have an impact on Rite Aid stock  because high demand for the bonds may cause demand for the equity to be low. And it’s worth noting for near-term traders that the bond prices haven’t moved lately, even as the RAD stock price has bounced 50% off its August lows. Consequently, the bonds are more attractive than they were a month ago.

In the most bullish scenario, Rite Aid stock will outperform Rite Aid’s debt. It will also outperform CVS, and Walgreens, and probably over 90% of the stocks in the market. The sheer size of the company’s debt is why RAD stock has fallen so far – and why RAD stock can soar if it’s finally able to lower its debt.

But there’s a long path to that bullish scenario,  and some outside help is needed. And in anything less than a blue-sky outcome, investors likely will do better if they buy alternatives to Rite Aid stock.

As of this writing, Vince Martin has no positions in any securities mentioned.

After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.


Article printed from InvestorPlace Media, https://investorplace.com/2019/09/consider-alternatives-rad-stock-price/.

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