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Rite Aid Earnings Overtake Deal Hopes

Stocks in this article: RAD WAG

NEW YORK ( TheStreet) -- Rite Aid (RAD), the debt-laden drug store giant that reported a $500 million-plus annual loss is a "Buy" even if the company can't attract a buyer like Walgreen (WAG), according to a Guggenheim Partners analysis that cuts against speculation of a possible merger.

On Thursday, Guggenheim Partners analyst John Heinbockel raised his price target on the Camp Mill, Pa-based drug store giant to $2.25 a share from $1.60 on a boost in expected earnings at the company's stores. That earnings-based price target lift comes as the company's shares have surged nearly 60% in 2012 driven, by M&A rumors.

"Our optimism stems entirely from fundamentals and not from potential M&A. In our view, a strategic transaction is highly unlikely," notes Heinbockel in a March 15 research note. "This largely reflects the absence of logical buyers at acceptable prices. We find it difficult to make the case that Walgreen should spend $8.0B or more to acquire Rite Aid ."

In November, Susquehanna Financial Group analyst Joseph Stauff wrote in a note to clients that the company could be a target of Walgreen, the largest U.S. drugstore chain. With Rite Aid, Walgreen would further bolster its near 30% market share, distancing it from CVS Caremark (CVS), the industry second.

Presently, Walgreen has 7,811 stores that have helped the company draw in $73 billion in sales and a profit of $2.7 billion in 2011. In contrast, Rite Aid hasn't been able to turn a profit on its near 5,000 stores and $25 billion in revenue in 2011. Rite Aid is expected to lose 12 cents a share in its first quarter earnings due on Apr. 12, while Walgreen is expected to earn 77 cents a share in profit, according to consensus estimates compiled by Zacks.

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Earlier in March, Credit Suisse analyst Edward Kelly said that a Rite Aid acquisition would help Walgreen push against drugstore competition by pharmacy benefits managers like CVS Caremark and Express Scripts (ESRX), which is currently trying to secure a $29 billion 2011 acquisition of Medco Health Solutions (MHS).

That deal has been slowed by regulators on antitrust concerns. After a $1.1 billion deal for prominent New York drugstore chain Duane Reade in 2010, Kelly noted that Walgreen wouldn't face big concentration threats on a Rite Aid buy. A deal could drive up to $650 million in cost savings, noted Kelly.

" We believe Walgreens may conclude that it needs more scale to protect profitability and acquiring Rite Aid is the only viable option," wrote Kelly. One challenge could be the $6 billion in debt that Rite Aid carries, which could pull Walgreen credit ratings below investment grade, noted Kelly who estimated a takeover could cost up to $4 a share.

But Heinbockel of Guggenheim Partners says that investors don't need to hope for a merger to validate a $2-plus share price for Rite Aid. "Our bullish Rite Aid thesis, which revolves around accelerating EBITDA growth on the maturation of Wellness Plus and the generic wave, is in the early stages of playing out," writes Heinbockel. He estimates that the company's earnings before interest, taxes, depreciation and amortization will grow 7% this quarter, with the potential that growth to double to 14% in the first half of 2012.

It means that even with a deal fueled stock that's risen over 100% since September 2011, long-term investors may have a fundamental justification to own Rite Aid shares that sit below $2 on a Thursday pullback.

"To be fair, a portion of the most recent strength does stem from increased speculation about the potential for a strategic acquisition, which we deem unlikely. We do, however, see additional upside over the next 6-9 months on strengthening fundamentals."

Rite Aid is expected to earn over $26 billion in 2012 revenue, helping to narrow an over half billion dollar 2011 loss to $317 million, according to consensus analyst estimates compiled by Bloomberg. Sales and losses are expected to moderate in 2013, with analysts giving Rite Aid a $1.91 average price target on 3 "buy" ratings, 4 "holds" and 2 "sells."

For more on Rite Aid shares, see 11 stocks under $11 for a rebound .

-- Written by Antoine Gara in New York

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