Risks with Ride Aid Turnaround

Management at the Rite Aid Corporation (RAD - Analyst Report) is executing a turnaround strategy centered on increasing the profitability of the existing store base, which includes improving the product mix with generic and private label products. Nevertheless, management acquired the Brooks Eckerd chain prior to a convincing turnaround in profitability.

Also, Wal-Mart's (WMT - Snapshot Report) initiative to enter the retail generic drug market should pressure the company's pharmacy margin. Importantly, the company has a large debt burden. Given management s EPS guidance for fiscal 2009, the stock is rated a Sell.

Wal-Mart's entry into the retail generic drug market may prove detrimental to Rite Aid's pharmacy sales. Given the company's structural competitive disadvantages and high debt position, the stock should be valued on a price-to-sales basis. Most recently, the stock declined to $1.95 or 0.058 times expected post-merger annualized sales.

Due to the company being in a turnaround phase with a high debt burden, the determination of Rite Aid's stock valuation is challenging. Until there is strong evidence of sales improvement, the tentative target price is $2.50 based on a 0.075 price-to-sales ratio (based on expected post-merger annualized sales).

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