To Stay at $20, Rite Aid’s Got to Do More

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I last wrote about Rite Aid (NYSE:RAD) in early October. At the time, RAD stock was trading below $7.

To Stay at $20, Rite Aid’s Got to Do More
Source: Andriy Blokhin / Shutterstock.com

The funny thing is Rite Aid’s stock traded above $170 as recently as January 2017. To be trading in single digits — it hit a 52-week low of $5.04 in August — was a disturbing reality for America’s third-largest drugstore chain.

I won’t retell how Rite Aid got there because it’s too messy. Plus, most investors already know the story. Suffice to say, no one in their right mind should have been thinking about buying RAD stock.

And yet, here we sit, less than four months later, with Rite Aid up 78% since my Oct. 2 article. Even more surprising is the fact Rite Aid traded up 248% between Oct. 2 and Dec. 27, when it hit a 52-week high of $23.88.

Although Rite Aid’s lost its momentum since then, to be trading in double digits has got to be considered a victory for CEO Heyward Donigan, who was appointed in August at the very time its stock had bottomed.

At this point, it feels as though Rite Aid is at the crossroads.

Where it goes next really depends on Heyward’s ongoing plan to transform a sleepy drugstore chain into a provider of health and wellness services where its pharmacists are at the center of this turnaround.

To get to $20 — and stay at $20 — Donigan and her management team have got to do more to convince me that it’s the real deal. Here’s why.

The Latest Quarter Was Better

There is no question that the third-quarter 2020 results released Dec. 19 had a lot to do with Rite Aid’s big run-up at the end of 2019.

Although the top-line revenues only increased by $12 million, or 0.2% year-over-year to $5.46 billion, its adjusted EBITDA increased by 10.7% to $158.1 million. Sales were stable, and profitability improved, both steps in the right direction.

Donigan stated in its press release:

Our team delivered a strong quarter that provides us with momentum as we prepare to roll out our long-term strategy and position Rite Aid Corporation as an innovative leader in our industry.

Adjusted EBITDA grew in our retail business due to tight expense control and prescription count growth in our retail pharmacies, which benefited from solid growth in immunizations. At the same time, we saw improved pharmacy network management at EnvisionRxOptions.

As I said back in October, while I thought aggressive investors should consider buying Rite Aid under $7, the rest of InvestorPlace’s readership should wait to see Donigan’s entire plan.

Nothing has changed to alter my opinion. At $12, the risks of investing at this point outweigh the rewards. Until Donigan reveals more of the company’s plans and another quarter of results is in the books, Rite Aid ought to be off-limits for most investors.

It Is Still a Financial Mess

On Jan. 6, Rite Aid announced an exchange offer for holders of its 6.125% senior notes due 2023, to exchange up to $600 million of them for new 7.500% senior secured notes due 2025. Essentially, it gains two more years on $600 million of its debt in exchange for an additional 1.375% in interest.

In a world where corporate debt is at record levels, the move barely registered with investors.

What’s a 1.375% increase in interest on $600 million in debt? Approximately $8.3 million per year. The adjusted EBITDA gain in the third quarter paid for the higher cost of servicing its debt. So, who cares?

You should.

At the end of November, Rite Aid had a pro forma leverage ratio of just under six. Anything over four is generally considered worrisome. Fear not, Moody’s Analytics believes the ratio of debt to EBITDA is a poor predictor of the default rate, so all is well in the world.

But is it?

Currently, Rite Aid’s Altman Z-score is 1.63. The Altman Z-Score indicates the likelihood of bankruptcy over the next 24 months. Anything under 1.81 suggests the probability is high.

Now, I’ll admit I’ve seen much worse, but it should open your eyes to the fact Rite Aid stock has come a long way despite the fact its balance sheet is still weaker than it needs to be to warrant a $20, or even $12 share price.

My InvestorPlace colleague, Luke Lango, recently wrote how Rite Aid’s turnaround to date isn’t nearly as strong as it should have been to warrant the kind of stock move that happened at the end of December.

I couldn’t agree more.

Most of Rite Aid’s gains in the third quarter came from accounting-related moves and less from operational efficiencies.

If Rite Aid is to get to $20, it has got to do a lot more in the next few quarters to warrant a billion-dollar valuation.

Right now, I don’t see it anywhere close. For now, I’d recommend staying on the sidelines.

At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.


Article printed from InvestorPlace Media, https://investorplace.com/2020/01/to-stay-at-20-rite-aids-got-to-do-more/.

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