Overview
Rite Aid Corporation (NYSE: RAD) is a national drugstore chain operator. As of March 4, 2017, the company operated 4,536 stores in 31 states and the District of Columbia. The company also operates 99 clinics through its wholly-owned subsidiary, RediClinic. Rite Aid was originally incorporated in 1968 and is headquartered in Camp Hill, Pennsylvania.
Operations
Rite Aid has two primary operating segments, Retail Pharmacy and Pharmacy Services:
Retail Pharmacy consists of Rite Aid retail stores, RediClinic, and Health Dialog. The primary source of revenue for retail stores is prescription drugs, while the balance is made up of ‘front-end’ items which include over-the-counter medications, cosmetics, household items, food and beverages, and seasonal items. The company also has a large portfolio of private brand items.
RediClinic is a Houston-based retail clinic operator that was acquired by Rite Aid in April 2014. The clinics are staffed by nurse practitioners and physician assistants who are trained and licensed to treat common conditions and provide preventative services.
Health Dialog is a provider of health coaching and analytics acquired by Rite Aid in April 2014. Health Dialog helps health plans, employers, and physician groups improve healthcare quality while reducing costs.
Pharmacy Services consists of the company’s EnvisionRx subsidiary, a full-service pharmacy benefit management company. In addition to administering prescription drug programs, EnvisionRx offers mail-order and speciality pharmacy services. It also services patients enrolled in Medicare Part D.
Walgreens Merger
On October 27, 2015, Rite Aid entered into a merger agreement with Walgreens Boots Alliance Inc. (NYSE: WBA). Walgreens agreed to acquire all of the outstanding shares of Rite Aid for $9.00 per share in cash, indicating a total enterprise value for the company of $17.2 billion. The merger was approved by Rite Aid shareholders on February 4, 2016, and was intended to be completed within 12 months of the original announcement.
However, closing has been delayed by regulatory approvals. Since Rite Aid and Walgreens are two of the three largest drugstore operators in the United States, clearance from the United States Federal Trade Commission (FTC) is required to complete the transaction.
It was reported that in July 2016 that Walgreens was working with the FTC to determine what assets would need to be divested in order to gain approval (primarily overlapping drugstore locations). Due to the FTC’s ongoing antitrust review, the merger date was eventually extended to January 27, 2017.
It should be noted that Fred’s (NASDAQ: FRED) agreed in December 2016 to acquire 865 Rite Aid stores for $950 million in cash.
Unfortunately for Rite Aid shareholders, the transaction did not close as scheduled and the end date was pushed to July 31, 2017. Furthermore, the amended agreement lowered the offer price for Rite Aid’s outstanding stock. If the FTC requires Walgreens to divest fewer than 1,000 stores, it will pay Rite Aid shareholders $7.00 per share. If Walgreens is required to sell more than 1,200 stores, the price falls to $6.50 per share.
Fourth-Quarter Earnings Review
Revenue for the 14 weeks ended March 4, 2017, totaled $8.5 billion, a three percent increase from the fourth quarter of 2016. This was driven primarily by the Retail Pharmacy segment which benefitted from an extra week of sales (versus 13 in the prior year). Average weekly revenue decreased to $610.1 million from $636.2 million in 4Q 2016.
Despite the extra week of sales, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) decreased to $264.3 million (or 3.1 percent of revenue) for the 14 weeks ended March 4, 2017, down from $383.0 million (or 4.6 percent of revenue) for the 13 weeks ended February 27, 2016. This decline was attributable to a reduction in prescription reimbursement rates and lower prescription volumes.
Comparable store sales growth has been negative across all categories for the past two quarters. As shown in the chart below, trends have generally been negative since the beginning of FY 2016.
Rite Aid’s net loss for the quarter was $21.1 million, and $3.2 million on an adjusted basis. The adjusted net loss of $0.00 per share beat the consensus analyst estimate of $0.02 per share.
With respect to the balance sheet, Rite Aid has significant debt obligations. At March 4, 2017, the company’s long-term debt and lease financing obligations (less current maturities) totaled $7.3 billion. Subsequently, the company’s debt-to-EBITDA ratio at March 4, 2017, increased to 6.4, up from 4.9 one year earlier.
Stock Performance
As of April 25, 2017, shares of Rite Aid closed at $3.97, gaining more than six percent on the day after the company reported better than expected earnings results. However, uncertainty regarding the Walgreens merger has weighed heavily on the shares. Year-to-date, the stock is down more than 50 percent.
In mid-January (prior to the disclosure of the amended merger agreement), shares traded as high as $8.77, slightly below the previous offer price of $9.00 per share. More recently, shares of Rite Aid have traded as low as $3.70, reflecting the revised offer range of $6.50 to $7.00 per share and the market’s generally skeptical view of the merger receiving approval from the FTC.
Following are selected analyst ratings and price targets:
| Analyst | Firm | Rating | Price Target | Date |
| Lisa Gill | J.P. Morgan | Neutral | $6.50 | 3/15/2017 |
| George Hill | Deutsche Bank | Hold | $6.50 | 3/3/2017 |
Analysis
The market reacted positively to Rite Aid’s better than expected fourth-quarter results. However, the underlying fundamentals including comparable store sales growth remain weak. Furthermore, in an updated proxy statement filed March 3, 2017, the company provided an internal forecast which projected adjusted EBITDA for the 2018 fiscal year to decline seven percent.
At this point, Rite Aid is essentially trading on the likelihood of the merger with Walgreens being completed. As noted above, the FTC’s review of the deal has taken longer than anticipated, and could still be blocked. In order to acclerate the process and meet its scheduled closing date of July 31, 2017, Walgreens is considering a declaration of certified compliance, which would force the FTC to rule on the merger within 30 days.
There are a few factors which could influence the FTC’s decision. The first is whether it believes Fred’s has the ability to absorb the divested stores and become a national competitor to Walgreens in addition to CVS Health Corp. (NYSE: CVS). Another consideration is that the FTC is operating with only two members, one Republican and one Democrat, which could limit the FTC’s ability to act.
Still, Walgreens is doing everything it can to ensure the FTC grants its approval. The company is repotedly planning to present a revised asset sale proposal which could include additional stores, distribution centers, software, and personnel.
Summary
As noted above, Rite Aid is trading primarily on the anticipated success of the Walgreens merger. While there is significant uncertainty surrounding the deal, Walgreens CEO Stefano Pessina is firmly committed to the transaction.
Walgreens appears to be willing to increase its concessions to the FTC and offer a greater number of store divestitures. This could push the offer price for Rite Aid shares toward the lower bound of $6.50 per share. Therefore, a price target of $6.50, in-line with other analysts, appears reasonable.
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