Drugstore chain, Rite Aid Corp. (RAD - Free Report) may seem like the fabled forbidden fruit of Eden for most at the moment, particularly after its merger deal with Walgreens Boots Alliance Inc. (WBA - Free Report) fell apart on Jun 29. Concurrently, the company also reported dismal first-quarter fiscal 2018 results and entered a fresh deal with Walgreens to sell 2,186 stores to the latter.
The whole chain of events has drastically impacted the stock’s performance as evident from the 20% decline witnessed since the announcement. Further, the company has significantly underperformed the Zacks categorized Retail – Pharmacies and Drug Stores industry’s fall of 1.4% in the same time frame. Looking back, Rite Aid has declined as much as 67.4% in the last one year, compared with the industry’s fall of 15.7%. Let’s delve a little deeper and try to understand the reasons behind the slump.
Reasons for the Decline
As already stated, Rite Aid and Walgreens terminated its long-standing merger agreement following the Federal Trade Commission’s (FTC’s) closed door meeting on Jun 28, which dropped hints on the minimal chances of the deal being approved.
The deal has been awaiting FTC’s approval ever since the announcement of the agreement in Oct 2015. FTC’s concerns were mainly regarding the lack of a strong competitor in the drugstore space. With Walgreens and Rite Aid being the second and third-largest drugstore chains in the U.S., the FTC believed the merger could give rise to a duopoly, leaving behind the industry leader (by size) – CVS Health Corporation (CVS - Free Report) .
Further, Rite Aid’s dismal earnings results for first-quarter fiscal 2018, released simultaneously, disappointed investors. The company posted adjusted loss of 5 cents per share for the first quarter that was wider than the Zacks Consensus Estimate of a loss of 2 cents. Further, this compared unfavorably with the year-ago period earnings of 2 cents. Additionally, the top line remained soft, with comps declining on account of lower pharmacy and front-end sales. Moreover, unfavorable reimbursement rates continued to strain margins, as evident from the 100 basis points contraction in the adjusted EBITDA margin this quarter.
Will the New Deal Provide Some Solace?
While Walgreens and Rite Aid called off the merger, the two major industry players entered into another fresh deal. Per the deal, Walgreens will buy 2,186 Rite Aid stores, associated distribution assets and inventory. This all-cash deal worth $5.175 billion is expected to conclude in six months, on a cash-free and debt-free basis. Apart from this, Rite Aid will also get termination charges of $325 million from Walgreens, in cash.
Management expects the new agreement to place the company as an independent drugstore chain, alongside being a pharmacy benefit manager with robust control in core markets. Well, Rite Aid will continue to operate its pharmacy benefit manager – EnvisionRX, RediClinic and Health Dialog. Further, the company intends to use the funds from this deal to pay down a part of its huge debt, thus improving leverage levels, easing balance sheet and improving financial flexibility.
All said, this deal is likely to make Rite Aid a smaller, yet stronger firm with lesser exposure to the pressures of the aforementioned unfavorable pharmacy reimbursement rates.
Well, though the new deal is definitely a breather for the troubled drugstore chain, whether the companies’ succeed in getting FTC’s approval on this deal is yet to be seen. Further, if approved, how Rite Aid revives its troubled income statement and operations as an individual company will decide its fate. Currently, the company carries a Zacks Rank # 5 (Strong Sell).
A better-ranked stock in the broader Retail-Wholesale space is Burlington Stores Inc. (BURL - Free Report) , sporting a Zacks Rank #2 (Buy). Further, the company’s long-term EPS growth rate of 15.9% and share price growth of 7.1% in the last six months help it to stand strong in the industry. Moreover, the company flaunts a superb earnings surprise history. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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