With Any Turnaround Already Priced In, Avoid Rite Aid Stock

High debt and lease liabilities make RAD stock overvalued

Beleaguered Rite Aid (NYSE:RAD) has traded wildly in the past month. Rite Aid stock has zig-zagged between $7 and over $9/share since Sept, 1.

With Any Turnaround Already Priced In, Avoid Rite Aid Stock
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Hearsay and speculation may move RAD stock, but long-term fundamentals are not on its side. The company has struggled to survive in a more competitive pharmacy environment.

A fraction of the size of competitors CVS Health (NYSE:CVS) and Walgreens Boots Alliance (NYSE:WBA), Rite Aid struggles to remain profitable. The company’s heavy debt load is another burden.

But can RAD stock pull off a turnaround? Is a strategic buyer waiting in the wings? No, and double no. At the company’s current valuation, the RAD stock price is inflated. Here are just a few reasons why investors should avoid Rite Aid stock.

The Never-ending Turnaround

On September 26, Rite Aid released earnings for the fiscal year ending August 2019. The performance continued to be weak, with revenues of $5.37 billion, slightly down from the prior year’s quarter ($5.42 billion).

A 1.6% decline in retail pharmacy sales was partially offset by growth in the Pharmacy Services segment of 1.1%. Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) fell ~10.7% from the prior year’s quarter.

But once again, the company has a turnaround plan. With a new CEO (Heyward Donigan) at the helm, the company is taking steps to bring profitability back to levels seen in years prior. This would give a shot in the arm to the RAD stock price. But with Rite Aid’s decades-long decline, it seems like a long-shot.

But Donigan could pull it off. On Sept. 24, InvestorPlace contributor Chris Lau discussed Rite Aid’s new CEO. Lau broke down her experience in healthcare marketing, especially in the digital space. This type of next-level expertise is just what the doctor ordered for RAD stock.

If Donigan can’t save Rite Aid, Chapter 11 may be the next stop. It has already happened to smaller pharmacy competitor Fred’s (NASDAQ:FRED). InvestorPlace’s Vince Martin talked about bankruptcy in his September 17 Rite Aid article. $3 billion of Rite Aid’s outstanding debt matures in 2023. Unless RAD improves EBITDA margins significantly, it could be hard to refinance.

However, whether a turnaround happens or not, the RAD stock price already prices in potential upside. Let’s take a look at valuation, and see how Rite Aid stock stacks up to peers.

Rite Aid Stock Is Priced Right

Rite Aid lists its net debt at $3.57 billion. But financial screeners include the company’s operating lease liabilities as debt. This is now common practice with retail stocks. The company has over $3.2 billion in current and long-term operating lease obligations. This bumps up RAD’s enterprise value to $7.37 billion.

At the current RAD stock price, shares trade at an Enterprise Value/EBITDA (EV/EBITDA) ratio of 16.4. CVS Health’s EV/EBITDA ratio is only 11.1. Walgreens Boot Alliance trades at an even lower EV/EBITDA (9.2).

For FY2020, Rite Aid projects adjusted EBITDA between $510 and $550 million. Even with these improved operating margins, its valuation would still be high. Using the FY2020 estimate, Rite Aid’s EV/EBITDA ratio would be between 13.4 and 14.5.

A strategic buyer could cut a lot of Rite Aid’s operating costs, improving EBITDA. Walgreens tried to buy Rite Aid back in 2015, but after years of regulatory hurdles, Walgreens settled for buying 1,932 of Rite Aid’s locations for $4.3 billion.

In 2018, privately-held Albertsons was going to merge with Rite Aid, giving control to Albertsons shareholders. Shareholders of Rite Aid stock balked, scrapping the deal. After two failed M&A transactions, a new deal is unlikely. But that does not stop investors from speculating on another deep-pocketed strategic buyer: Amazon (NASDAQ:AMZN).

Amazon has an in-store pickup partnership with Rite Aid. But that doesn’t mean they want to buy RAD lock, stock, and barrel. Amazon is making big moves in the retail pharmacy space, including the purchase of PillPack. Instead of buying RAD, they could add pharmacies to their Whole Foods locations. It would be costly to modernize Rite Aid stores to the level expected from the Amazon brand.

Rite Aid stock needs a miracle. But Amazon or any other large buyer is not that magic bullet.

The Bottom Line on Rite Aid Stock

With takeover talk a long-shot bet, RAD stock is banking on a turnaround to move the needle. A new CEO brings fresh blood into the operations. But years of mismanagement, a heavy debt load, and a lack of scale hamper these plans. At the current valuation, a turnaround is already priced into the RAD stock price.

With this in mind, the stock is a hard pass. Investors likely can find more solid turnaround plays elsewhere. Given the volatility in the RAD stock price, shares could shoot higher on speculation. But long term, Rite Aid stock is not a strong investment opportunity.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2019/10/turnaround-priced-in-rite-aid-stock/.

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