Alcatel-Lucent (ALU) and Rite Aid (RAD) have been two of the market's top performers over the last year. Moreover, both created new 52-week highs earlier this week, with Alcatel trading nearly 200% and Rite Aid over 265% above each stock's 52-week lows. Unfortunately, these are two companies that are operating in completely different directions.
Despite Gains, Still Cheap
One of the true bright spots with both Alcatel-Lucent and Rite Aid is that neither needs a significant level of revenue growth to add substantial value to their stock.
Alcatel-Lucent has a market cap of $6 billion, but revenue of nearly $19 billion, thus giving the stock a price/sales ratio of about 0.3. In comparison, Cisco trades at nearly 3.0 times sales.
Rite Aid is valued at $3 billion, which is just 0.13 times its sales. CVS trades at 0.67 times sales.
You might wonder why these two companies trade at such discounts to their respective industry leaders. The answer lies in margins. Rite Aid's profit margin is about one-fourth of CVS' and Alcatel's, with an operating margin of 1.79% doesn't even compare to the 22% of Cisco. Hence, the market wants operational improvements more-so than top-line growth, and it's the prospects for operational improvements that have taken these stocks to new 52-week highs.
Rising With Higher Margin Hopes
One good thing about a stock that is ridiculously cheap relative to sales is that expectations are always low. Rite Aid and Alcatel-Lucent had both been beaten down in the years prior to 2013 but have both risen on hopes of better days ahead.
Rite Aid has rallied behind three consecutive quarters of net income, and its first full-year of profitability in six. Like other pharmacies, Rite Aid's margins have exploded higher in the last few quarters due to the effect of new generic drug introductions.
Generic drugs pay higher premiums to pharmacies, meaning that with a high quantity of new generics, Rite Aid's profit per script has risen. Moreover, the company has been restructuring its business for the last couple years, closing and renovating its poor performing stores.
Alcatel-Lucent's strong performance has been speculative. After a 90% loss in the five years prior to 2012, Alcatel announced this massive restructuring plan involving the divestment of unprofitable segments and monetizing its assets. As a result, profitability would rise.
The company borrowed a couple billion dollars from Goldman so that it could fund the temporary struggles of its "plan." Clearly, the market responded favorably.
Can Gains Continue?
Now that you understand why these stocks have traded higher, the level of gains created, and the amount of value that's still present, it's time to ask the question if either will continue to trade higher.
First, let's look at Rite Aid, in which I'd like to direct you to an article by clicking here. I already explained that new generic introductions lead to higher margins. But in the linked article I look at the $31 billion in blockbuster drugs that are losing patents in the next two years.
Essentially, 2014 and 2015 will be great years for new generic introductions. With Rite Aid already trading considerably cheaper than its competitors, I see no reason why the stock won't continue to climb. In my opinion, Rite Aid is the perfect example of a stock that was beaten down so badly, and for so many years, that the market is rushing to try and adjust its valuation from being a non-profitable to a profitable company.
For the last five years, Alcatel-Lucent has executed a plan, and that plan has been to lay off employees while maintaining the size of its business. The reason that Alcatel traded from $0.9 to $2 from October 2012 to June 2013 is because investors thought management was doing something different.
At this point, the company had already reported interest in selling its submarine segment, a business worth over $1 billion. However, investors thought that Alcatel may sell its Optics, Managed Services or its Fixed Line businesses as well. Then, the overhang of a declining low margin business(es) would be eliminated from the company's equation. Thus, creating higher margins, and adding more cash to pay off its debt.
Instead, the company has backed out of this plan as all upper level management who supported the original divestment plan have resigned or were forced out. Alcatel reported back in June that the new plan would consist of layoffs and selling $1.25 billion in assets. In other words, more of the same, but only going through with the sale of its submarine unit, a deal that was already priced into the stock.
However, this time around, Alcatel has $2 billion borrowed from Goldman that will be added as debt to be paid back. For more information on the company's new plan and how it differs from the original, you can click here and here, for a detailed analysis.
Insanity is defined by doing the same thing over and expecting a different result. Alcatel-Lucent's stock moving plan is nothing more than a continuation of a process that took its stock from $15 to $1 over a five year period. In my opinion, this does not end favorably for Alcatel-Lucent or its investors.
With that said, I'd like nothing more than for Alcatel and Rite Aid to trade higher by another 100% in 2013. Last year I chose both as my co-2013 Values of the Year. Therefore, strong performance reflects good on me. However, my call was based on an operational plan that I thought could work, and would add long-term value to an undervalued stock. While Alcatel may trade higher for the next few months, I think Rite Aid is the stock that will see higher highs.
Rite Aid was chosen as my co-Value of the Year because of the patent cliff in biotechnology. The company traded at the deepest discount to sales in the pharmacy space and had the most to fundamentally gain. Looking ahead, all of the macro events that led to higher margins still exist, and upcoming introductions will continue to bolster margins. So far, all of my short-term price targets have been met, including my latest at $3.50, and I maintain my long-term target of $7. In my opinion, this company is simply too cheap.