BERKO: Rite Aid has wrong management formula
Friday, August 17, 2012 7:00 AM
Dear Mr. Berko:
In 1986, you told me to buy five shares of Apple Inc., and I did at about $40 a share. It has split three times, and my first five shares have turned into 40 shares that sell for more than $600, for a total of $24,000. I’ve read your column in Durham for 30 years and never said thank you for that help. Now I hope you can help me again. I shop at Rite Aid and have been looking at the stock for about a year. Do you think it would be a good idea to buy it? One of my friends has been a pharmacist for the company for about 15 years, and he told me to buy the stock because it could move up to $4 or $5 in the next six months. I have $2,500 to gamble with for a speculation, which I could use to buy 2,000 shares of Rite Aid Corp. And I have $5,000 that I’d like to put into an 8 to 10 percent income stock that might have some growth potential but isn’t very speculative. Thank you very much for everything.
D.P., Durham, N.C.
Lots of folks in the past few years purchased Rite Aid (RAD-$1.20), but they did so for the wrong reasons. I did, too. In early 2008, Peter Purdy Pawkins, Ph.D., a former medium-shot investment banker at Lehman Bros., was blood-red certain that RAD would be merged into Walgreen Co. (WAG-$35.53). Lehman declared bankruptcy later that year. I sold my RAD at a loss! And I haven’t talked to that Lehman guy since. I’m told he now owns two Subway sandwich shops in California. That merger rumor still surfaces about every six months, forcing RAD’s normal daily trading volume to increase eightfold or tenfold. So far, no cigar!
RAD is the nation’s third-largest drugstore chain, with 4,700 locations. It expects to report $26 billion in revenue this year with the aid of 90,000 employees. And that revenue, which has been flat as a flapjack since 2007, refuses to budge higher. This fiscal year – ending in February – will be the seventh consecutive year of losses, and if all goes according to plan, in February 2014, RAD will extend that losing streak to eight consecutive years. I imagine that this losing streak requires a uniquely skilled management team. In fact, since 1996, there have been only five years in which RAD was able to post a profit, and now the company’s balance sheet looks as if it was used for toilet paper. RAD’s mired in debt; its obligations (about $8 billion) are seven times its market cap; and operating income covers about 65 percent of interest expenses. There are 868 million shares outstanding, each with a negative book value of $3.05 and a balance sheet so laden with debt that even Attila the Hun wouldn’t consider a takeover.
And because WAG recently inked a new agreement with Express Scripts (pharmacy benefits manager), there are no merger benefits to a WAG takeover. But I think RAD could solve its earnings problem if management changed the water supply and coffee service at its Camp Hill, Pa., headquarters.
You might care to peek at The GDL Fund (GDL-$11.99), formerly known as The Gabelli Global Deal Fund, which went public in mid-2007 at $20. This non-diversified closed-end fund trades at a significant 12.6 percent discount to net asset value and pays a swell 32-cent quarterly dividend, which yields 10.7 percent. The Gabelli folks manage this exchange-traded fund, which focuses on merger/arbitrage transactions, corporate reorganizations involving stubs, spinoffs and liquidations. If, as some expect, merger, liquidation, reorganization and spinoff activities increase over the next few years, GDL could increase its dividend back to 40 cents or higher, and an increase in share price likely would follow. And while you are waiting for GDL’s business activity to improve, you can wait in modest comfort with a double-digit dividend return.
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