After Rite Aid Corp. (GDR) over the past few years is like watching a soap opera – lots of drama and a few bad actors. While I don’t currently believe the company will file for Ch.11 bankruptcy within the next three years, that doesn’t necessarily mean I think Rite Aid is a buy at current prices. The company faces a very difficult future and bankruptcy is still a very real possibility at the end of 2023, if it does not create a growing and stabilized business model.
Some people think Rite Aid could file for bankruptcy
Investors might find it strange that there are frequent statements about a possible bankruptcy of Rite Aid in various media editions because usually a stock selling for $20 is not considered a candidate for bankruptcy. For many, however, Rite Aid is currently selling for $1.10 and was even a “penny stock” earlier this year, as they mentally account for the 1-20 reverse stock split from May 2019.
The reason many investors fear that a stock split is an indicator of a future bankruptcy filing is that they are looking at other companies that have had large stock splits and they have finally applied for Ch.11. Chesapeake Energy (OTCPK: CHK) had a 1-200 reverse split and filed for bankruptcy almost immediately after that, which wiped out shareholders. Border communication (OTCPK:FTRCQ) had a 1-15 reverse split in 2017 and filed for bankruptcy in 2020. When their reorganization plan finally goes into effect, it will reverse their shares. Ascena Retail Group’s Ch.11 bankruptcy plan also wiped out shareholders in 2020 after the company went through a 1-20 reverse split in late 2019. Not all reverse splits lead to the bankruptcy of the company . Citigroup (VS), for example, had an inverted 1-10 split and is doing well now.
Rite Aid has posted a loss of $1.35 per share over the past 9 months and remains heavily leveraged. They currently have $3.2 billion in long-term debt and $2.7 billion in long-term operating leases, compared to $611 million in equity. Collectively, this is a yellow flag for a potential bankruptcy filing.
Some investors also view selling assets and renting them out to raise additional cash as a sign of financial weakness. The company sold a distribution late last year for $65 million in a sale-leaseback transaction.
Bankruptcy filings are often caused by one or more “triggers”. Common potential triggers:
Maturing debt. The first debt maturity is effectively December 31, 2022 for $90.3 million of 6.125% unsecured notes, as that is the maturity date of their credit facility, if they don’t refinance the 6.125% Notes prior to December 31, not April 2023, which is the actual maturity date of the Notes. Based on the statements filed, management expects this amount to be paid/refinanced prior to this date. (See below)
This 2023 maturity was a major issue last year, but Rite Aid had a series of swap offers to effectively extend the debt maturity to 2026. These swap offers were very costly for the company because she had to issue secured notes with 8% coupons for the 7% unsecured notes, plus some cash. Their next major debt maturity is December 2023, when their revolving credit facility and FILO term loans mature. So they have about almost 3 years to further stabilize their finances and renegotiate those loans.
Source: December 17 Presentation
Breaches of covenant. After reading the credit agreement, I don’t see any positive/negative clause that could become a problem. There are no strict financial covenants, such as minimum interest coverage. There’s still a potential problem, though, and it’s a very technical violation that could result in a notice of default. For example, Wells Fargo Bank (WFC) and CBL & Associates Properties (OTCPK: CBLAQ) are in dispute (opposing case 20-0345) on the bank’s assertion of various technical defects (I regard them as technical and insignificant), which CBL believes is partly responsible for their eventual Ch.11 bankruptcy filing. It almost seems that if the banker of a company in financial difficulty wants to find a way to force bankruptcy, the bank can become very “creative”.
Contentious judgments. There are currently no pending cases that would result in major judgments, which was the cause of Windstream Holding’s bankruptcy filing in 2019.
Cash flow. Their December 17, 2020, annual cash flow forecast for fiscal year 2021 was $50 million to $100 million. Initially, however, I was alarmed by the apparent low cash position at the end of their last quarter of just $50.8 million versus $218.2 million nine months earlier, but that was because a sale of their customer accounts had not yet been finalized. Accounts receivable sales are a common business practice and not really a sign of major trouble. Again, it looks like cash flow in the immediate future isn’t an issue.
Conclusion: I don’t see any of the common triggers pushing Rite Aid into Ch.11 bankruptcy through the end of 2023.
Rite Aid Valuation
Just because I don’t expect a bankruptcy filing in the near future doesn’t mean I’m bullish on the stock. Using guidance for fiscal 2021 from their December 17 conference call presentation of adjusted net earnings per share of $0.45 to $0.85 and current RAD stock price of $21.96, the market values the company at 49x-26x. These multiples are unrealistic for this highly indebted company that has experienced an operational/earnings roller coaster in recent years. Using the median adjusted net earnings per share of $0.65 and a more realistic multiple of 15x, the result RAD’s stock price is $9.75.
Directions for the 2021 financial year
Source: December 17 Presentation
Some investors use the average store price of $2.26 million that Walgreens Boots Alliance (WBA) paid off 1,932 Rite Aid stores in 2018 and multiplied that figure by the 2,461 stores in February 2020 to get $5.562 billion, as an indication of the company’s value. They then subtract $3.225 billion in debt and divide that $2.337 billion by 55.25 million RAD shares outstanding to get a value of approximately $42 per share.
I have very serious reservations about this valuation approach because it assumes that the purchased stores are on average the same value as the remaining stores. A detailed analysis should be made of each of the stores purchased and the stores remaining. Also, there are many factors to consider, such as the value to Walgreens of a specific purchased store because there are no other Walgreens in that shopping area, which would make that store very valuable to Walgreens.
Problems I have with Rite Aid
I have a number of issues with Rite Aid.
First, 1,845 (75%) of their 2,461 stores, as of February 2020, were in just five states (CA 540, MI 260, NY 318, OH 208, and PA 519). Plus, most of their stores are in states that aren’t growing as fast (or shrinking) as the rest of the country.
Second, I have reservations about management. I think that statement on page 32 of their latest 10-Q indicates a problem:
The total annual long-term debt principal repayments for the remainder of fiscal 2021 and beyond are as follows: 2021 — $0; 2022—$0; 2023—$0; 2024—$1,531,808; 2025—$0 and $1,716,305 thereafter. These aggregate annual long-term debt principal payments assume that the Company has redeemed or refinanced its existing 6.125% Notes prior to December 31, 2022.”
Rite Aids has $90.3 million in notes maturing in 2023. Putting $0 for 2023 and then a statement at the end is misleading, in my opinion. Moreover, the statement does not even give the amount of the maturing 6.125% notes. For some this might not be a problem, but for me it indicates a potential management credibility issue. (It is unaudited.)
Third, I think the company/management does not fully understand their customers and their Rite Aid purchases/purchases. When I am in New York, I frequently shop at various Rite Aid stores, but have never bought prescriptions from these stores. (I only buy one prescription and get it in Florida.) For me, these stores are a place to buy snacks, protein shakes, and personal care products. Although general merchandise represents only 17% of sales, it is a way of attracting customers to their stores on a daily basis. So when a customer needs to pick up a prescription, they use the Rite Aid store where they buy snacks, because they feel like a “regular” in that store. They might be less likely to use competitors, including online ones.
Sure, prescriptions and health-related items are essential for Rite Aid, but they need to be more creative in increasing the daily foot/drive traffic in order to retain customers in their stores. They could create a great new coffee to sell fresh by the cup in select stores or have soda fountains selling soft drinks. Many of their stores actually compete with gas stations for many non-prescription items. I’m not sure management fully understands how to attract more frequent customers to their stores and I don’t think they fully understand their potential customers. They need to broaden their reach, in my opinion.
The success of Rite Aids’ exchange offers last year has extended the avenue for stabilizing the business. Because I don’t see anything that should force them out of business in the near future, I think the Ch.11 discussion is out of order until at least fall 2023.
The current market valuation on RAD stock is unrealistic based on management’s forecast for fiscal year 2021. I would currently value RAD at less than $10.