Rite Aid's common stock is an attractively priced option on an improving fundamental picture at the company. The equity is an extremely levered stub that trades at 7x current year FCF, and as low as 2x next year's FCF. While the second lien debt has rallied from 20 to the mid-80s (13.3% yield on 2015 paper) and the unsecureds from 10 to 61 (13.5% yield on 2027 paper), the common remains at more depressed levels. With competitors reigning in expansion plans relative to past rates, the competitive situation should improve. Rite Aid has a new mgmt team in place and is pursuing new avenues to improve performance of stores. Generics are likely to become a much bigger part of the market over the next few years, helping profitability. We believe the stock could rally to the $3 - $4 range with marginally positive news flow while the downside is limited in the near-term given cost-cutting opportunities and lower competitive pressures.
$1.2B mkt cap
$6B debt at face, ~$5.2B at mkt(next maturity $191mm unsecured in 2013)
$8B in capitalized operating leases ($1B annual expense)
For purposes of comparison, let's define EVL as enterprise value plus capitalized leases (at 8x annual expense)
RAD CVS WAG
Sales: $26B $97 $59
EBITDA: $1B $7.2 $4.2
%: 3.8 7.4 7.1
EBITDAR: $2B $8.9 $6
%: 7.7 9.2 10.2
EV 8.4 55 38
EVL 16.4 72 56
EVL/S 0.63 0.74 0.95
Rite Aid deserves a lower sales multiple than peers CVS (which also has a PBM business) and WAG. Rite Aid's retail non-prescription productivity per store is lower (store sizes are roughly equal btwn the three chains) at $1.8mm vs $2.3mm for CVS and $3.2mm for Walgreens. Rite Aid has been capital constrained for a number of years which has limited its ability to invest as heavily in the company. Nevertheless, according to the new management team there are many available opportunities to improve margins and drive sales.
Currently Rite Aid's equity trades at 7x free cash flow. Free cash flow of $200mm for this year is derived from $1B EBITDA guidance less $550mm interest expenses and $250mm in capital expenditures. The free cash flow is extremely sensitive to same store sales and cost cutting/optimization. A positive 1% same store sales comp corresponds to a $50mm increase in EBITDA -- given that competitors have pulled back from historical 8% growth in square footage to 3% as of this year, positive same store sales seem a possibility. Additionally, the company has identified over $1.1B of potential EBITDA improvements through mix, customer flow, and cost reduction/optimizations, though they are conservatively targeting $534mm of them in the first few years.
If Rite Aid has a 3% positive comp, realize half their conservative estimate, and can refinance their debt at slightly less expensive rates (cut $75mm off interest expense), all of which seem very achievable given the macroeconomic backdrop and decreased competitive pressures, this coming year's FCF would rise by $490mm. This would leave the current stock price at 2.3x FCF, which we believe will cause the stock to rise significantly.
On the other hand, even with negative comps and difficulty achieving even half of their targeted EBITDA gain, the company has a few years to improve operations given the fact that all their debt has been termed out. The company's liquidity position has greatly improved since March of 2009. Maturities have been pushed to 2014 and beyond, giving themselves significant time to work on operations.
The company's covenant position is generally strong. One negative covenant to watch is the consolidated fixed charge coverage ratio, which needs to exceed 1.1 to 1 if the $1B revolving credit facility has less than $150mm in capacity remaining. It is defined as (EBITDA + rent - capex + integration capex) / (interest + rent + dividends) for the trailing four quarters. Currently the company is below the ratio, but has $730mm available capacity on the revolver (the remaining is taken up by letters of credit).
- Increasing competition
- Weak consumer
- Difficult refinancing market
- Adverse healthcare regulation
- Next few quarters should provide data on cost cutting
- Positive comps at any point have potential to highlight cheapness