Shares of struggling pharmacy retailer Rite Aid (NYSE:RAD) went on a roller coaster ride of epic proportions in September. RAD stock price entered September at $6.50. A few days into September, RAD stock was trading just shy of $10. By the end of the month, RAD stock price had come crashing back down to $6.50.
In other words, in a matter of one month, RAD stock both rallied more than 50%, and dropped more than 30%.
In the big picture, the wild roller coaster ride that RAD stock price went on in September is much ado about nothing. The company’s fundamentals didn’t change at all in September. Instead, its second-quarter numbers announced in September confirmed that Rite Aid remains a struggling pharmacy retailer that can potentially stabilize its sales and margins over the next few years. But at the same time, it’s uncertain whether Rite Aid can generate high enough profits to support a price tag for RAD stock north of $5.
Consequently, I think investors would be wise to ignore the recent roller coaster ride of Rite Aid stock. Instead, they should focus on its fundamentals, which continue to support the bear thesis on RAD stock.
Forget the Roller Coaster Ride
Investors would be wise to ignore both the 50% rally and the 30% plunge by Rite Aid stock in September. Instead, they should just think of RAD stock as a name that delivered a flattish return last month.
The roller coaster ride is much ado about nothing. Rite Aid’s fundamentals haven’t changed at all. Instead, there was a big shift in the markets from momentum stocks to value stocks, as investors reassessed the valuations of all stocks. Rite Aid stock got caught up in that shift, and because the shares were really beaten up, RAD stock subsequently skyrocketed.
But, just as quickly as the momentum-to-value shift came about, it went away. Now momentum stocks are back to outperforming value stocks. As the value trade has unwound, RAD stock has given up all of its gains.
So the roller coaster ride of Rite Aid stock in September was driven by macro factors largely irrelevant to the company’s fundamentals. Therefore, the recent volatility of RAD stock price should be ignored.
Focus on the Fundamentals
Investors would be equally wise to turn their focus to the fundamentals of RAD stock. Unfortunately, the company’s second-quarter numbers reported in September confirm that those fundamentals remain weak.
Here’s the big picture. Rite Aid is a niche, specialty pharmacy retailer that has largely been squeezed out of the retail landscape by the competition. Among its competitors are e-commerce marketplaces like Amazon (NASDAQ:AMZN), which recently entered the market, and retail titans like Walmart (NYSE:WMT) and Target (NYSE:TGT) which have expanded their retail drug operations. Rite Aid’s traffic, revenues, margins, and profits have consequently slipped over the past several years.
They continue to slip today, and the trend remains unfavorable. Its revenues dropped 1% year-over-year in Q2, the worst top-line decline in over a year for Rite Aid. Its EBITDA margins fell 0.24 percentage points year-over-year, in-line with its average quarterly margin drop of the last two years The company ran up a huge loss in the quarter. Importantly, on a trailing 12-month basis, its revenues and margins are dropping at a fairly consistent and bearish rate.
Rite Aid’s full-year guidance calls for its revenues and margins to stabilize into the end of the year. That could happen, as its partnership with Amazon could provide a nice traffic and sales tailwind for the company. But, even if that does happen, its fundamentals will still broadly remain depressed, characterized by flattish sales growth, anemic margins, and tiny profits.
Rite Aid Stock Isn’t Worth $7
According to my numbers, RAD stock isn’t worth $7 today. Instead, it’s worth less than $5.
Rite Aid’s revenues aren’t going much higher anytime soon. In a worst-case scenario, its revenues will continue to drop at a steady 1%-2% rate per year. In a best -case scenario, Rite Aid will leverage its new Amazon partnership to turn its steady revenue declines into slight growth, in the ballpark of 0%-1% annual increases.
Assuming the best-case scenario, renewed, consistent revenue growth should be accompanied by slight margin expansion as management continues to focus on cost reductions.
That all sounds good. But the problem is that this company is paying $200 million or more every year to service its huge debt load, and its operating profits may never get big enough to fully fund the interest bill and produce a sizable profit. At best, I think Rite Aid’s EPS can reach 50 cents by fiscal 2025.
Based on a forward price-earnings multiple of 16, which is average for the market, and a 10% discount rate, that equates to a 2019 price target for RAD stock of below $5.
The Bottom Line on RAD Stock
Rite Aid stock went on a roller coaster ride in September. Forget about that roller coaster ride. It had nothing to do with the company’s fundamentals. Its fundamentals remain depressed and continue to indicate that RAD stock can drop further.
Because of that, I think the best thing to do with Rite Aid is remain on the sidelines.
As of this writing, Luke Lango was long AMZN.
