Don’t Give Up on Rite Aid Corporation (RAD) Stock Now

It's looking like the bottom is finally in for RAD stock. Here's how things look with the new Walgreens deal.

For investors in the Rite Aid Corporation (NYSE:RAD), things have gone from bad to worse. RAD stock has slumped for almost the entirety of 2017, falling from $8.50 in Janaury to just $2.30 now. Year-to-date, the stock is down 73%. But is that enough of a beating yet, or could Rite Aid plunge even lower?

Don't Give Up on Rite Aid Corporation (RAD) Stock Now
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The latest major decline came after Walgreens Boot Alliance Inc (NASDAQ:WBA) terminated its long-running proposal to acquire Rite Aid outright. Walgreens initially offered $9 per share for RAD stock. It subsequently cut that offer to $6.50, but even that was too high, apparently.

Walgreens has put forward a new version of the offer; now they want to acquire only about half of Rite Aid’s store base. This should appease the FTC regulators, while leaving Fred’s Inc (NASDAQ:FRED) with nothing for its troubles. Investors are cold even on this new deal, however; RAD stock has further slumped from $3 into the low $2s over the past month.

What the New Deal Brings to the Table

Many merger and arbitrage players clearly owned Rite Aid in hopes of receiving the full $6.50 per share from Walgreens. Hence, the sharp drop once the companies published the details of the new proposal.

That said, it’s not all bad news for RAD stock owners.

For one thing, the company gets a sizable break fee, since the original Walgreens proposal didn’t close successfully. As a result, Rite Aid scores $350 million. That amounts to 31 cents of received-break-fee per share of RAD stock.

On top of that, Walgreens is still offering to buy 2,186 Rite Aid stores, and they’re willing to pay $5.2 billion for said assets. As of its last reporting period, Rite Aid had $7.2 billion of debt on its balance sheet, and much of the company’s profitability issue has resulted from its excessive interest payments. With $5.5 billion in cash coming from the break-up fee and store sales, Rite Aid should be able to get its balance sheet back onto firmer ground if it decides to remain an independent company.

Recently, Rite Aid revealed that the remaining half or so of its stores that it would have after the Walgreens deal finishes are surprisingly strong. Rite Aid stated that its remaining stores account for close to $750 million of the company’s $1.1 billion in overall EBITDA. And the remaining locations would average $6.1 million in annual sales, as opposed to $5.7 million for its current 4,500 or so locations.

So, Rite Aid is keeping a meaningfully better sampling out of its overall store base.

The FTC Should Approve This Deal

Now, there are some observers still concerned that the FTC might block even this much smaller version of the deal.

The argument goes that if Rite Aid can no longer serve as competition for Walgreens, it would have the same effect as if the original deal had been consummated. However, post-store sale, Rite Aid would still have more than 2,000 locations, and the cash infusion would repair its balance sheet enough to ensure its ability to compete for years to come.

There still is plenty of talk going around on social media about Rite Aid going bankrupt, but this simply doesn’t make sense. Assuming Rite Aid pays down debt with the $5.5 billion in cash, its remaining Debt/EBITDA ratio would fall to around industry medians — very close to CVS Health Corp (NYSE:CVS).

Sure, it won’t necessarily be all-clear for the company; management has to figure out how to get store traffic trending back up. But bankruptcy is off the table in the near-term, and the FTC should approve this deal if it really cares about fulfilling its stated policy objectives.

What Happens to RAD Stock?

Regardless, sentiment remains negative for Rite Aid shares.

Several investment banks slammed the company’s prospects following the re-cut deal. Both Evercore ISI and Bank of America dropped the company to “underperform” and issued $2 price targets for the stock. Even from today’s low price, that’d be almost 20% more downside. And short sellers clearly concur, between June 30 and July 31, short interest in RAD stock more than doubled. It has spiked to 115 million shares, or about 11% of RAD stock’s float.

Unfortunately for longs, there probably isn’t a “quick fix” to get the stock back to $4 or higher.

It’s highly unlikely that, Inc. (NASDAQ:AMZN) would acquire the firm. Though bulls are touting this theory, integrating the Whole Foods Market, Inc. (NASDAQ:WFM) purchase will likely serve as enough brick-and-mortar exposure for Amazon at the moment. Additionally, Rite Aid doesn’t have the same high-end stores and upper-class customer base that Whole Foods is so good at attracting.

Rite Aid still may find a suitor, but don’t expect a flashy takeout offer from a white knight.

My Verdict

That said, there could be real value here for patient investors. Bears have recently amped up their bets against the company, but seemingly without much strong justification.

Yes, RAD stock has continued to decline, but at some point, enough is enough. Shares are down more than 70% on the year. Yet, the company is likely to keep 60% of its EBITDA base, along with receiving more than $5 billion in much-needed cash to wipe out most of the company’s debtload.

Rite Aid still has a challenging situation ahead of it. Its store performance has been floundering; management was probably distracted with FTC bureaucratic matters. However, with its balance sheet in much better shape, and retaining a strong core base of stores post Walgreens deal, there is reason for optimism. This is still a high-risk situation, and the stock could certainly get to those $2 price targets if more bad developments hit. But at this point, the balance of factors seem to favor a long position.

Just don’t bank on a new buyout offer coming in soon.

As of this writing, Ian Bezek owned WBA stock. He had no positions any other of the aforementioned securities. You can reach him on Twitter at @irbezek.

Article printed from InvestorPlace Media,

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