Like many retailers, Rite Aid Corporation (RAD) has been struggling with low-profit margins and negative cash flow for years. In fact, Rite Aid has not seen consistent profits since the 1990s. The main issue being low prices at stores with generally low demand due to ever-growing competition. The company has made a significant effort to expand its pharmacy and other health-related revenue, but it has a long way to go.
Rite Aid has also made an effort to reduce leverage by reducing debt and growing its reliance on leasing. Still, the company’s total liabilities are extremely high, particularly considering its chronic lack of cash flow. COVID gave the company a temporary boost to sales, but its stock price recently plummeted toward long-term lows and those sales slowed. The company does not have significant cash reserves and has an awful Caa1 credit rating which signals a very high default risk.
As you can see below, the company desperately needs to improve its operating position and has been stuck with a stagnant stock price and significant equity dilutions for decades:
With COVID’s positive factors for the company likely to end over the next quarters and its balance sheet position poor, it seems possible Rite Aid will struggle to survive. That said, it does have a strategy to improve margins which may make for a turnaround opportunity.
Rite Aid’s Turnaround Strategy
The company is making an effort to stop the bleeding. Rite Aid is rebranding its pharmacy benefit company as ‘Elixir’. Rite Aid’s pharmacy benefit manager is its new cornerstone. The PBM market is increasingly dominated by a few major integrated health-care companies like UnitedHealth (UNH) and CVS Health (CVS).
Rite Aid’s goal is to become the dominant mid-market less-integrated PBM. This would be good as the PBM business is historically profitable. However, there has been growing scrutiny and regulation legislators and the U.S Supreme Court that may allow states to regulate certain aspects of prescription drug reimbursement in order to stop rising drug costs. This may create difficulties for Rite Aid’s strategy.
The company has also made efforts to improve profits at the store-level. This includes training pharmacists in holistic care and customer engagement. As explained in their latest conference call:
These efforts empower Rite Aid pharmacists to engage in informed discussions with our customers and educate them on a broader spectrum of remedies that not only support their whole health, but also position Rite Aid to continue to grow share and sales through mixed basket purchases.
The company calls this “unlocking the value of our pharmacists”. Others may also call it “training pharmacists to be sales-people”. Still, if done correctly, this could be an intelligent strategy that benefits both Rite Aid and its customers. As Rite Aid’s management notes, Pharmacists are often underutilized despite them being among their most expensive employees. It would likely benefit Rite Aid if pharmacists’ customer-activity boosted sales for over-the-counter medicines. Additionally, these efforts may help Rite Aid boost sales from flu shots or, if allowed, the COVID vaccine.
Is There Any Value in Rite Aid?
Many investors are betting that the company will turn around. Indeed, Rite Aid has seen $260M in TTM operating cash flow and even higher levels in year’s past while only having a market capitalization of $540M. This could make the company seem very cheap. That said, its positive cash flow may have only been due to wind-fall COVID profits as its Q3 cash flow was -$350M.
As you can see below, its cash flow has been extremely unstable in recent years and has trended toward zero to negative levels:
This is almost entirely due to changes in margins as its revenue changes very little year-to-year. RAD’s stock price is highly dependent on its operating cash flow since the company has significant depreciation and intangible costs/gains that cloud its earnings.
The company desperately needs cash, it only recorded $92M in cash in the bank last quarter which was the lowest level in the past nine years. The company has nearly $2B in accounts receivable with $470M in receivable minus payables. This has risen over the past few years which gives the company a potential source of cash as it sells receivables, but it is also a sign that customers are not paying on time.
Overall, Rite Aid’s financial situation is poor. The company has high-interest debt and increasingly dependent on leasing. It has significant total liabilities and virtually no positive cash flow. Rite Aid is making acquisitions as seen in its recent $95M purchase of 150-year-old Bartell, but it may only be serving to add liabilities and overhead when it desperately needs to clean its balance sheet.
The Bottom Line
The core issue is that competition for its retail and pharmacy business is extremely high. It is making efforts to grow into the few profitable categories available to it, but even then competition is mounting. Quite frankly, I see little reasons Rite Aid will stabilize its profit margin for the time being. Additionally, I do not see any significant reasons to believe Rite Aid’s stock will turn around.
The only reason I could see Rite Aid benefiting shareholders is if it is acquired. In the past, there was to be a merger with Walgreens Boots Alliance (WBA), but the deal fell through due to FTC anti-trust concerns. With an enterprise value of only $4B, Rite Aid is far cheaper than it was years ago, so it is still possible a buyer will be interested in the company. Given its inability to turnaround for decades, I do not think it would be a great investment, but the increasingly consolidated healthcare industry may disagree.
Overall, I would certainly not buy RAD. The company has depended on equity-dilutions to raise cash for years and, as its market capitalization declines, its ability to continue to use this mechanism does as well. The company is making efforts to turnaround, but the fact that it continues to make acquisitions in the face of a high-risk financial situation is a red-flag since it indicates possible agency risk.
While RAD may be headed to zero over the next few years, I would not short the stock until it is clear buyout interest has faded. Even still, Rite Aid has survived with near-zero average profits and high debt for many years. The company may simply be stuck in permanent stagnation that will only end when interest rates rise or when/if equity investors capitulate.
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