On the "Rite" Track

11/05/2004 12:00 am EST


Vahan Janjigian

Editor, Bottom Line's Money Masters Stock Report

Rite-Aid is a second time pick from Vahan Janjigian. His Forbes Special Situation Survey  scored a 6-month, 90% gain the last time he bought the stock. He says, "Now that the shares have weakened again, we think it is time to consider buying back the stock."

"Rite Aid (RAD NYSE) has been operating drugstores since 1962. Based on sales and total store count, it is the third-largest chain in the country. Only Walgreen and CVS are larger. Once a highflier, RAD got hit with a major accounting scandal that caused the stock price to plummet. Shares of Rite Aid quintupled in value in just five years, reaching a peak of more than $50 a share in early 1999. But the stock quickly plummeted when investors learned that the books had been cooked and that management had overstated revenues and earnings for several years. Financials were restated, which resulted in net losses all the way back to fiscal 1998. Retained earnings, which were $1.3 billion in fiscal 1998, now show a $4 billion deficit.

"The good news is that RAD is on the road to recovery. Several members of the former management team are now in jail and new management has initiated a turnaround that is already producing profits. Unprofitable stores have been closed, others have been revamped, several key partnership agreements have been signed, and creditors have been working with the company to address the debt burden. Thirty new stores are expected to open by the end of fiscal 2005. A hundred more are planned for fiscal 2006. Furthermore, demographics are in the company’s favor. The American Society of Health estimates that more than 44% of Americans take a prescription medication on a daily basis. This figure will rise as the population ages. Thanks to baby-boomers and longer life expectancies, RAD expects total US pharmacy sales to increase about 30% over the next three years.

"The turnaround isn’t complete and RAD remains a risky company, but it is finally headed in the right direction. Over the past four quarters, net income available to common stockholders approached $200 million on revenues of $16.9 billion. While these are very encouraging results, RAD is by no means out of the woods yet. The most significant investment risk involves the company’s extremely heavy debt load. In fact, total debt stands at more than $3 billion. Despite the investment risks, we believe it makes sense to take a position in RAD at this time.

"We last recommended RAD in April 2003 when it was selling below $3 a share. We advised subscribers to get out of the stock in October after it had almost doubled. The stock finally topped out in early December and has been on a downward trek ever since. The stock really took a hit on September 7 when management announced weak August same-store sales and revised downward revenue and earnings projections. We believe investors overreacted to the news, which provides an excellent opportunity for others to get in at an attractive price. Our discounted cash flow analysis indicates that RAD is grossly undervalued. Although we may be a little early, we think the recent weakness in the stock has brought it to a very attractive level. We are encouraged by RAD’s prospects and believe the stock will rise to $6 a share within two years."

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