Rite Aid And Its Debt

| About: Rite Aid (RAD)


While Rite Aid is recovering, some investors remain worried about its debt.

Rite Aid refinanced loans in the third quarter and this negatively impacted earnings.

Further refinancing could hurt short-term results, but strengthen the long term.

Rite Aid (NYSE:RAD) just reported a strong quarter that highlighted its ongoing turnaround. With initiatives such as wellness stores, flu shots and its McKesson (NYSE:MCK) deal boosting numbers, the drugstore posted 5.4% comps growth and raised guidance. However, Rite Aid still has two major weaknesses - the debt remaining from its purchase of the Eckerd stores and its low margins in comparison to other pharmacies. Rite Aid needs to make more progress on its debt to convince some investors the turnaround is real. Details from the earnings call show Rite Aid has been reducing its interest costs, and it might have even done better than its bottom line figures indicate because of this.

The Opportunity

Even though Rite Aid's share price has gone up by about a dollar per share in the last week, it still has a relatively low price-to-sales ratio. Morningstar lists a P/S ratio of 0.3 for Rite Aid compared to 0.9 for Walgreen (WAG) and 0.8 for the overall industry. So the drugstore's stock could double or even triple if it achieves a profit margin like those of its peers, which makes it an interesting investment.

One of the factors dragging down Rite Aid's profit margin is the cost of servicing its debt. While interest expense fell from $103 million in the fiscal third quarter of 2014 to $97 million in its latest quarter, this is still relatively high in comparison to total income. Rite Aid reported $105 million in net income for the fiscal third quarter of 2015; the drugstore is paying nearly as much in interest as it is earning for its investors.

Debt Repayment Costs

Rite Aid did pay off some of this debt early, but this came at a price for the drugstore. The chain reported a debt retirement loss of $19 million for the quarter. The company provided some details about this in its earnings call:

Our liquidity has decreased by $184 million year-over-year due primarily to the fact that in October, we used borrowings on our revolving credit facility to fund the early redemption and payment of the full $270 million of our $10.25% senior secured notes.

We had $780 million of borrowings outstanding under our $1.8 billion revolving credit facility, and had $71 million of outstanding letters of credit. Total debt net of invested cash was lower by $91 million from last year's third quarter.

So Rite Aid paid down a bit of its debt, but the real story here is the refinancing. The drugstore replaced higher interest loans with lower interest loans, but incurred a loss by doing this. Rite Aid further explained that it took a hit of $0.02 per share this quarter for paying off its debt early. Since earnings were $0.10 per share, this is significant. Rite Aid's diluted EPS would have been 20% higher if it hadn't paid down its debt.


As the turnaround progresses, better terms could allow Rite Aid to refinance even more of its debt. The company also went into detail about its financing plans for the future:

In December, we launched the financing transaction to re-price and upsize our revolving credit facility. We expect to increase the amount of the facility to $3 billion and to use the additional proceeds to repay the $1.15 billion of first lien term loans that are currently outstanding. We expect this transaction to close in early January and expect annual interest savings of approximately $20 million as a result.

Rite Aid's third quarter ended in November so this event took place in the fiscal fourth quarter of 2015. This refinancing could pay off in fiscal 2016; the company will save around $5 million per quarter for a boost of around 5% to net income. The debt refinancing loss reported by Rite Aid in the third quarter shows that the refinancing could have a short-term effect on earnings, though.


It looks like Rite Aid does plan additional debt refinancing and this could strengthen the company in the long term. However, this could result in weaker EPS results in the short term, possibly resulting in an earnings miss. If Rite Aid does miss on earnings because of debt retirement losses that could produce a buying opportunity because the drugstore would make more money later with its interest expenses reduced.

Disclosure: The author is long RAD.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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