Rite Aid Corporation (RAD)
Investment Thesis Summary: Rite Aid is a “turnaround” undervalued stock with a significant upside potential. Due to improved company fundamentals and performance the stock price is up 550% over the last 1.5 years. Yet, I believe the company’s stock continues to be undervalued. It is still far from where it could be if the company continues to execute its turnaround plans. In fact, based on today’s valuation metrics, if Rite Aid is to approach the valuation metrics and margins of its competitors over the next 3-5 years, Rite Aid’s stock should appreciate 2-5X from today’s price.
THE STORY:
Please click on this presentation to learn about the company, future plans and their turnaround story.
The company has a number of things going for it.
1. Aging Population
This is straight forward and self explanatory. According to US Census Bureau the population of those 65 & Older in the US will be at 56 Million by 2020. That is about a 40% increase from today’s levels. It doesn’t take a genius to figure out that these older Americans will be visiting Rite Aid more often to buy larger quantities of drugs as they continue to age. Driving sales and profitability higher.
2. Drug Deal/Distribution
In mid February 2014 The company announced an expanded distribution agreement with McKesson (MCK), a massive drug retailer. While this renewal is technically an expansion of their existing deal into 2019 it gives us an important clue to future growth and profitability.
The drug industry is changing. Today, most drugs are bought in massive quantities by the likes of distributors like McKesson. This gives both McKesson and Rite Aid higher pricing power and flexibility. In addition, the so called “Patent Cliff is in play. It is estimated that between 2011 and 2017 close to $130 billion worth of brand drugs will lose patent protection and become generic. When that happens, the margins for both pharmacies and drug distributors should increase further.
That is already becoming evident at McKesson where operating margins have risen from 1.63% to 2.03% since 2011 and at Rite Aid where operating margins went from (-2.16%) to +3.76% over the same period of time. As you can see a massive jump. As more generic drugs come on the market over the next few years, it is likely the operating margin will continue to expand.
3. Turn Around/Improved performance
Please see the presentation for other data points on turnaround and improved performance. Click Here
4. Undervaluation:
I believe that standard Intrinsic Value Calculation/Valuation will not yield very good results in this case because the company is in the process of a turn around. To determine future valuation and potential undervaluation at this time, we must look at properly run competitors. Walgreen Co (WAG) and CVS Corp (CVS) in particular. We have to look at their existing valuation and assume that Rite Aid will move closer to such industry valuation metrics as it continues its turnaround plans.
The easiest way to do so is to look at Price/Sale Ratio. Again, the assumption here is that Rite Aid will continue to execute on its turnaround plan to reach industry metrics. Walgreen has a P/S ratio of 0.87 and CVS has a P/S ratio of 0.67
What does it all mean?
It means that if Rite Aid continues to execute its turnaround plan and reaches industry metrics over the next 3-5 years, its stock price should be between $17.10 and $22.10. Giving us a respective yield of 158% and 233% over the next 3-5 years. With any other operating or margin improvements the return should be much higher.
FUNDAMENTALS:
The stock is undervalued relative to today’s market.
|
Valuation Measures |
|
|
|
Financial Highlights |
|
|
||||||
|
||||||
|
||||||
|
||||||||||||||||||
|
||||||||||||||
|
||||||
The company financials are ugly, but getting better. If we are to look at the balance sheet, income statement and the cash flow statement the desire to invest is likely to disappear. However, we must be aware that by the point the financial statements will reflect improvement and return to stability, the stock price is likely to complete most of its climb.
What is the Intrinsic Value? Too many variables and unknowns to calculate here. I believe the values provided in the “Undervaluation” section above make a lot more sense in this particular situation.
TECHNICAL:
As you can see, the technical picture is incredibly strong here. Since its bottom 1.5 years ago, the stock has appreciated over 550% with no signs of a technical slow down and/or a reversal. Giving us an indication that most investors believe the turnaround story is developing (at this time) as this report suggests.
CONCLUSION, TIMING & POSITIONING:
XXXX
Please Note: XXXX is available to our premium subscribers in our + Subscriber Section. It’s FREE to start.
Did you enjoy this article? If so, please share our blog with your friends as we try to get traction. Gratitude!!!
