Due to increased generic pressure and the closing of unprofitable stores, Rite Aid will continue to lose revenue, yet because of its value/margins the market will not care. Therefore, let’s say that it loses 10% of its top line over the next three years and returns revenue around $23 billion. Rite Aid still has some work to do, and is nowhere near the efficiency of either Walgreen Company (NYSE:WAG) or CVS Caremark Corporation (NYSE:CVS). However, it is highly likely that during this time the company can achieve a profit margin of 1.5% with an increase in generics.
If Rite Aid can achieve a profit margin of 1.5% (roughly half of competitors) and sales of $23 billion by the end of 2015, and then trades with the industry average P/E ratio of 18 times current earnings, then a market cap of $6.20 billion, price of $6.85, is mathematically possible, and likely.
While a $6.85 price target may sound farfetched, you must remember that for this year the company’s high-end guidance is for net income of $33 million. Therefore, after eight quarters of improvement, net income of $330 million is very possible with the rate of new generics that are being introduced to the market. Also, keep in mind, if my 10% revenue loss is accurate this would still leave RAD trading with a price/sales ratio that is just 0.27, which is about half of Walgreen Company (NYSE:WAG) and CVS Caremark Corporation (NYSE:CVS). Therefore, the stock would still be cheap even at $6.85.
In my book, Taking Charge With Value Investing (McGraw-Hill, 2013), I lay out what is needed for a good speculative investment to return the largest gains. Rite Aid Corporation (NYSE:RAD) falls under the category of a speculative investment, but has (1) recent fundamental proof of improvement, (2) a business that is worth several times more than its market capitalization (sales/market cap), (3) a willingness among management to see and fix problems, and (4) a clear cut path toward efficiency, among several others. In my opinion, Rite Aid has all the makings of the perfect speculative value investment, and as long as the plan stays on path, I think it’s a near can’t miss for very large returns.
The article After a Two-Day Rally, Is there More Upside Here? originally appeared on Fool.com and is written by Brian Nichols.
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