Is Rite Aid a Bad News Buy?

After Rite Aid (RAD 5.80%) abandoned plans to combine with grocery Goliath Albertsons, investors have taken to the sidelines. Can Rite Aid compete as a stand-alone pharmacy player, or will much bigger competitors and a heavy debt load derail its prospects?

In this clip from The Motley Fool's Industry Focus: Healthcare, host Kristine Harjes and Motley Fool contributor Todd Campbell explain why Rite Aid walked away from Albertsons and the impact of its decision on investors.

A full transcript follows the video.

This video was recorded on Aug. 15, 2018.

Kristine Harjes: Rite Aid, another company with a fantastic ticker, RAD, has also had a disappointing week. The stock is down nearly 20% over the last week, following the Thursday announcement that the company is terminating its $24 billion merger with grocery chain Albertsons. The announcement came on the eve of a shareholder vote. What's the story here?

Todd Campbell: The company desperately wants to go to prom, but it keeps getting stood up, Kristine.

Harjes: Aw, that's so sad! Poor Rite-Aid.

Campbell: [laughs] I know! Poor Rite-Aid! Rite-Aid is the third largest of the stand-alone pharmacy players. You have Walgreens, CVS, and Rite Aid. Rite Aid came to the conclusion a few years ago that, as a stand-alone company, it was going to struggle to compete against its much bigger foes, especially because it's been dealing with, for about a decade, a tremendous amount of debt that it took on through its own acquisition spree during the 2000s.

Initially, Rite Aid's solution was, "I know what I'll do! I'll sell myself lock, stock, and barrel to Walgreens." Regulators objected to that because they decided it would consolidate too much market power in the pharmacy market, so they blocked that deal. Rite Aid then had to go back with Walgreens and ink a new deal, in which they basically sold almost half of their stores, and a few distribution centers, to Walgreens in exchange for a pile of cash that they could then use to help delever their balance sheet.

Then, more recently, in May, Rite Aid finally found a suitor for the rest of the company, agreeing to merge together with the venture-backed Albertsons, which is one of the largest grocers in America. If you don't know the Albertsons brand, you may know some of the other brands, which include Safeway and, in the Northeast, Shaw's. That deal, however, has now also been scuttled. That's brought us back to square one as investors.

Harjes: A lot of the biggest shareholders in Rite Aid were not happy about the Albertsons deal. They seemed to think that Rite Aid was not getting a good enough valuation in this deal. It's interesting to me that shares plummeted on the news that investors got what they supposedly wanted. I can't really explain that one. [laughs] There are no breakup fees for either company. That's at least a small positive for Rite Aid.

Honestly, this company is really, really struggling. It's down to a $1.5 billion market cap. It still has a retail footprint, it still has a PBM, but I honestly can't say I think it's in value territory right now and might be a good buy. You look at the broader pharmacy retail landscape, and it's not even the best-positioned company in that space, and the entire space is being pressured by competition from Amazon. It has a really small scale. I don't know, I'm not very bullish on its future.

The one thing I will say is, if I could look into my crystal ball and make a prediction here, I can see the company being picked apart. If you separate the PBM from the retail business, I could see a little bit of promise in the PBM. Potentially, it could have a little bit of success if it's able to partner with some of these smaller health insurers that are looking to partner with a PBM that's not affiliated with a competitor, given how many other large PBMs are now affiliated with giant insurance companies. That would work to its advantage. We'll see. That's about all I have, as far as optimism for Rite-Aid goes. [laughs]

Campbell: I think one of the reasons they sold off was, the hope wasn't necessarily that the deal would get scuttled, but maybe that Albertsons would rework the deal and give Rite Aid investors a bigger share of the combined company. The way the deal was structured was, Rite Aid shareholders would end up owning 29% of the combined Albertsons-Rite Aid. The problem that investors had with that is, Albertsons being privately held, very hard to value that. What is Albertsons really worth? We don't know, because it's not publicly traded. We don't have that price discovery.

As a result, people were looking at it and going, "I don't know if we're really getting the value that we deserve out of this." Maybe it would have been nice if they were able to restructure the deal where Rite Aid shareholders got a little bit bigger share of the company. But even then, who knows. Maybe they would have balked at that, as well.

I have similar concerns about it on a stand-alone basis. Even with the pile of money they got from Walgreens, they still have, as of June, $3 billion in debt on the books. Their interest expense last quarter was $62 million. As a result of that interest expense, their net loss from continuing operations was about $42 million. Obviously, that interest expense remains a very big problem for the company. If they could solve that problem, theoretically, they would be profitable on a GAAP basis. But we just don't have a clear path for them to be able to do that.

And, if you look at the fact that CVS is combining with Aetna, and that's going to narrow the ability for Aetna members to go to Rite Aid, and what kind of drag that puts on it... Then, you look at Walgreens, and the fact that they own part of AmerisourceBergen, so they have some synergies that Rite Aid doesn't have. There are some real concerns about how this company competes as a stand-alone.

I think it should be one of those wait-and-see stocks. Let's see how this goes over the course of the next quarter or two, see whether or not they can start to get the prescription volume trends moving in the right direction.

Harjes: Given how long this saga has already played out, I feel like we'll be covering it for years to come. This thing has really stretched on. Rite Aid claims it's in discussions with an extensive list of third parties around a range of strategic options. Take that for whatever it's worth. Supposedly, there are interested buyers. But it's pretty clear that Rite Aid is in a somewhat desperate situation. I don't know that they're going to find a deal that's more favorable than this one with Albertsons would have been.

Campbell: It may be one of those things where people go, "Oh, maybe I didn't want to object to that deal after all." Time will tell. We'll have to keep a close eye on it.

Harjes: Yeah, we'll see.