Will Rite Aid Survive without Walgreens?

Stefano Pessina might be the most-stubborn chief executive on Earth, nothing seems to be deterring the Walgreen Boots Alliance (NASDAQ: WBA) CEO from his attempt to acquire Rite Aid (NYSE: RAD). Disturbingly, Pessina’s stubbornness might be the only thing protecting Rite Aid from total collapse.

The latest earnings report indicates that the number three drug-store operator in America will probably die without Walgreen’s help. Rite Aid is clearly in the death spiral and close to operating at a loss.

The death spiral is the pattern of events that occurs when a retailer is not making enough money to cover its expenses. Rite Aid is not there yet, but it is clearly approaching death’s door if the data posted by ycharts can be believed.

Rite Aid is in the Death Spiral

There is quite a bit of proof that Rite Aid is locked in the death spiral including:

• A net income of $4.053 million on February 28, 2017. That is down from $90.81 million in November. That shows income fell by $86.577 million, or by nearly 95% in just three months. If that continues Rite Aid will post a loss, for this quarter.

 

• A “profit margin” of -.25%

 

• A “free cash flow” of -$38.11 million.

 

• $225.86 in million in cash from operations for a company that reported revenues of $32.85 billion on February 28, 2017.

 

With numbers like that many people will wonder: why is Pessina so anxious to get his hands on Rite Aid? The answer is a simple one; its’ revenues are growing.

Between February 2016 and February 2017, Rite Aid’s revenues increased by $2.11 billion. The revenues rose from $30.74 billion in 2016 to $32.85 billion in 2017. There’s a lot of cash flowing through Rite Aid that might make somebody a lot of money if he can figure out how to capture it.

Why Walgreens Needs Rite Aid

The problem at Rite Aid is that its revenues are not growing fast enough to cover expenses. Walgreens which reported $116.08 billion in revenues; and $4.247 billion in net income on February 28, 2017, has the resources to cover Rite Aid’s expenses.

Walgreens also needs revenue growth because its revenues fell by $450 million between February 2016 and 2017. Walgreens reported $116.58 billion in revenues in 2016 and $116.08 billion a year later.

To add insult to injury Walgreens’ revenues dropped over by $740 million over the last quarter. Walgreens Boots Alliance reported $116.82 billion in revenues in November 2016, and $116.08 billion three months later.

This explains why Pessina wants Rite Aid, and why he is prepared to fight the Federal Trade Commission (FTC) to get it. Walgreens desperately needs some revenue growth.

The revenue growth is needed because Walgreens Boots Alliance is heavily exposed to a very troubled European economy. It operates around 4,600 stores in the United Kingdom; which is still reeling from Brexit, for example.

WBA will need to expand its footprint in the healthier United States to offset losses in Europe. It also needs to increase its sales of US prescription drugs; which are financed by Medicare and health insurance, to offset losses in areas like cosmetics and household cleaning supplies – which are under intense competition from Amazon, Walmart and dollar stores.

Since there were around 4,553 Rite Aid stores in 2016, the smaller drug chain is a good buy. Pessina will add almost as much retail space as Boots Alliance operates in the UK to his company’s US footprint by buying Rite Aid.

Why Rite Aid Needs Walgreens

Rite Aid needs Walgreen simply to survive because it is very close to death. Rite Aid stock was trading at $3.84 a share on May 15, 2017, which gave the company a market capitalization of $4.204 billion.

Beyond that Rite Aid has other problems including $10.98 billion in liabilities a number that almost equals its enterprise value of $11.37 billion, and $7.285 billion in long term debt. A major infusion of cash is needed and fast at Rite Aid if it wants to stay in business.

Since Rite Aid probably cannot tap the markets for that money a sale is in order. If the FTC succeeds in blocking the sale, the question of who else will buy Rite Aid arises.

Who else would Buy Rite Aid?

This brings us to the obvious question: who else would buy Rite Aid? There is actually a long list of potential suitors because of Rite Aid’s 4,533 locations and $32.85 billion in revenues.

Some potential purchasers for Rite Aid include:

• Kroger (NYSE: KR) – America’s largest standalone grocer already operates 2,244 pharmacies and revenues in the grocery business are stagnant. One potential use Kroger would have for Rite Aid stores would is as smaller neighborhood markets and cafes – to counter Aldi’s push into U.S markets. Another is as a pickup point for online grocery orders.

 

• Amazon (NASDAQ: AMZN) – The online retail giant is trying to reduce its delivery costs. Rite Aid stores would make perfect pickup points for merchandise ordered online and as base points for same delivery services. Buying Rite Aid might also give Amazon an entry point into the highly lucrative prescription drug business.

 

• Cerberus Capital Management – The equity giant owns the second largest standalone grocer; Safeway, which is a major pharmacy operator.

 

• Dollar General (NYSE: DG) and Dollar Tree (NASDAQ: DLTR). Buying Rite Aid would give these chains more locations and a presence in the pharmacy business. It might also get them into more lucrative urban markets.

 

• Aldi – The German discount grocer is spreading fast. Owning Rite Aid would give it more locations in new markets and pharmacies to counter Kroger and Walmart. Buying Rite Aid might help Aldi enter new states like Colorado.

 

• Lidl – Aldi’s arch rival plans to enter the U.S. market this summer, Supermarket News reported. Purchasing Rite Aid would give it a ready made U.S. footprint of 4,553 stores and all that pharmacy revenue.

 

• Fred’s (NASDAQ: FRED) – This smaller regional drugstore operator is in very sorry shape; it reported a “net income” of -$66.53 million on January 31, 2017. Fred’s was trying to buy 1,200 Rite Aids to help Walgreens comply with the FTC. If the Walgreens’ bid falls through Fred’s might try to buy all of Rite Aid perhaps with the aid of a private equity firm like Cerberus.

 

• Berkshire Hathaway (NYSE: BRK.B) – This is sort of a dark horse because Warren Buffett is down on retail right now. Yet we all know that Uncle Warren loves a bargain. If Berkshire Hathaway (NYSE: BRK.A) bought Rite Aid it would get $32.85 billion in revenues and 4,553 drugstores for around $4 billion. Rite Aid might also fit in well with some other Berkshire businesses including International Dairy Queen, Kraft Heinz, See’s Candies, Borsheims Fine Jewelry, Ben Bridge Jewelers and the distributor the McLane Company.

Rite Aid is not going to disappear any time soon despite its problems. No matter what happens at the FTC, Rite Aid will probably survive as part of a larger company; because its revenue is too valuable to disappear.