If the pharmacy chain Rite Aid (RAD) could fill a prescription for higher profits, investors might not be bailing out of the stock in droves. Since April of 2018, the company's share price has cratered by more than 90%, falling by nearly 50% so far this year.
Worse yet, there's not much reason to believe that things are going to look up anytime soon, if they ever do. Let's examine three red flags that indicate why Rite Aid isn't a good stock to buy right now.
1. Several long-lived downtrends show no sign of reversal
As a pharmacy stock, investors count on companies like Rite Aid to grow slowly and steadily over time, and many expect these types of companies to distribute excess cash flow in the form of dividends. If instead the company contracts slowly over time, it's a major issue and a significant barrier to investment. Therefore, the first major red flag for Rite Aid is that its performance has decayed somewhat over the last 10 years.
Consider this data in the chart below, which shows how Rite Aid's finances have deteriorated since 2014. Despite a mild decline in revenue, total expenses are rising as a percentage of sales, which is bad news for any retail business with thin margins. The bad news continues: Earnings before interest, taxes, depreciation, and amortization (EBITDA) are tumbling intermittently, and annual free cash flow (FCF) is steadily trending downward.
To add to investors worries, guidance for the 2023 fiscal year demonstrates that management only expects to bring in $23.5 billion in revenue, which is less than its $24.4 billion in trailing 12-month revenue. On top of that, Rite Aid is no longer profitable, with a profit margin of negative 0.69%.
Worse yet, it isn't clear exactly which aspect of the business is malfunctioning at scale. In theory, the pharmacy's customer base will regularly make use of their local retail locations, so it's possible that Rite Aid's stores are, on average, positioned in areas with low traffic or high competition. But should that be the actual issue, it would be an incredibly difficult one to fix.
2. It isn't deleveraging very fast
The other trouble with Rite Aid is that it's stuck with a hefty debt load, which significantly constrains its ability to adapt to the market.
As seen in the chart below, it's true that Rite Aid is making some progress in paying down its debt load over time -- but that progress is pretty minimal. And, with FCF falling, there isn't much hope to pick up the pace of deleveraging anytime soon. That won't stop new debt from coming due, of course.
Each dollar spent on servicing debt is another dollar that cannot be used for reinvestment into the business and reorientation toward its most profitable segments. The pharmacy isn't in danger of going bankrupt yet, but it might be in the next couple of years if things continue as they have been.
3. Rock-bottom valuation
The final red flag is that the company's price-to-sales (P/S) multiple is tiny in comparison to other national pharmacy chains like CVS Health (CVS 2.65%) and Walgreens Boots Alliance (WBA 0.58%). Whereas Rite Aid's P/S is an incredibly low 0.01, CVS clocks in at 0.48, and Walgreens at 0.29.
Such a low multiple compared to competitors often indicates that a particular stock is a bargain buy. But in this case, I think there's something different going on. Investors likely have very low expectations for the company's revenue growth moving forward. And that's never a good sign, especially when those expectations are dropping over time, like in Rite Aid's case.