When a stock is repeatedly picked as a turnaround and/or value play, I get suspicious. Real value usually stems from situations where everybody says "That stinks," not when a lot of people on TV say "Hey, maybe that's worth a look."
So it is with some doubt that I tackle the Rite Aid (NYSE:RAD) value story.
The market didn't like what it heard from the nation's No. 3 pharmacy on Thursday. Though the company did right by analyst expectations for the first quarter, it lowered its forward guidance. Investors responded by dropping the price almost 10%.
Simply put, performance was anemic. Sales fell fractionally on the back of a 0.3% decline in same-store sales. Though general merchandise sales were up 1.4%, the company's bread-and-butter pharmacy sales were down 1.2% -- not a good sign.
Top-line softness also reduced operating leverage, even when excluding the impact of store closing costs. On a more positive note, cash flow generation still seems to be relatively healthy, and the company is paying its bills with room to spare.
I believe that retail-sector turnarounds are particularly difficult. Once stores turn down, customers change their shopping habits, and those habits can be hard to break back in your favor. I think it's even worse in this sort of retail trade -- a clothier can always hope that the next season's fashions are a hit, but pharmacies can't really vary their offerings in quite the same way.
Complicating matters, Rite Aid must deal with a lot of debt and preferred equity if and when it recovers. Some of the dividends on those preferreds are payable in common stock, and since the principal converts to common stock, Rite Aid could find itself diluting common shareholders.
Turnarounds are among my favorite investments, and I've done well with them over the years. But part of that success depends upon being choosy and identifying the best candidates. With Rite Aid, investors must face a huge number of shares outstanding, the possibility of future dilution, and the reality of strong competition from the likes of Walgreen (NYSE:WAG), CVS (NYSE:CVS), and Wal-Mart (NYSE:WMT).
I'd say there's at least a 50-50 chance that the company will recover. I'm not sure I'd give its stock price the same odds.
Get right with more Rite Aid takes:
You can also get a snapshot of Rite Aid's Q1 2006 numbers here.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
