Drugstore Chain Is Still on Its Feet

02/15/2012 12:28 pm EST


Marc Gerstein

Editor, Forbes Low-Priced Stock Report

The death of this stock has been greatly exaggerated over the past couple years, and while not completely out of the woods, it's a better speculation than ever, writes Marc Gerstein of Forbes Low-Priced Stock Report.

This is our second feature on Rite Aid (RAD), the first having been on June 15, 2011. Given extremely negative rhetoric relating to RAD that has appeared since then, one might expect this position to be underwater.

Actually, though, the stock is up about 30% despite the more-risk-averse-than-usual stance that characterized Wall Street for much of 2011, while the Russell 2000 is down almost 2%. The disparity between the stock and the commentary warrants another close look at RAD.

The factors cited by those fearing corporate failure are very old news: a huge debt burden, red ink, a balance sheet loaded with intangibles, etc. That's why the stock is available to us well under the upper boundary of our under $3 universe.

Our task is to check that box off, so to speak, and move on to the next flash point, liquidity-whether RAD will continue to have the cash it needs to conduct its business, which, actually, is a two-part consideration.

One aspect of liquidity is having the cash to operate the business on a day-to-day basis. For RAD, this is a definitive "yes."

EBITD over the first three quarters of fiscal 2011 was $518.1 million, versus $391.5 million in interest expense. Adjusting EBITD for various non-cash charges brings it up to $668.6 million. Indeed, this state of affairs has prevailed consistently since 2007, when RAD's debt soared in the wake of its ill-timed acquisition of Eckerd.

The touchier aspect of liquidity is having cash to meet its debt maturities. Here, the answer is "it depends." Strictly speaking, RAD falls far short.

But long-term debt (the type that dominates RAD's balance sheet) is what can be regarded as "permanent" capital, as distinguished from short-term debt, which typically is taken for temporary needs such as the funding of an inventory buildup or to get funds the company can use while it waits for customers to pay bills.

The normal course of events is for companies (not just RAD but all companies, even those ranked AAA) to refinance long-term debt as it comes due, exceptions occurring where companies make strategic decisions to change their capital structures (as we presume RAD will when feasible).

That depends on the willingness of creditors to accommodate. And that, in turn, depends on creditor confidence in the company's business (which is why AAA companies don't break a sweat, while we do have to be concerned about firms like RAD).

Given the devastating hits even senior creditors often incur in bankruptcy, it takes a lot for them to say "no." So far, they've been saying "yes" to RAD, and have negotiated to the point where the company's next significant maturity hurdle occurs in 2015. I don't expect RAD to have the cash then either: the goal is to generate enough business progress to motivate creditors to continue to negotiate and accommodate.

That brings us to the final hurdle: business improvement. As discussed previously, the company is adding services (immunizations, new store formats such as wellness+, a loyalty program that has been successful in retaining regular customers that shop more, etc.).

None of these moves are earth-shattering, but they, along with a new Web site that lets customers upload photos for in-store printing on paper, mugs, etc., shows that RAD is doing the kinds of things viable businesses need to do.

Sales trends have been unspectacular but decent (although the mild winter may hit seasonal sales), with rival Walgreen's (WAG) termination of business with Express Scripts (ESRX) constituting a potential source of new pharmacy business.

With the stock priced where it is, we don't need to see RAD match up with CVS (CVS) or Walgreen. All we need is for it to keep generating cash, improving its stores, and eventually start chipping away at its debt.and it looks like this is achievable.

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