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Don't Get Too Bullish on Rite Aid's Recovery

Stocks in this article: RAD CVS WAG

NEW YORK (TheStreet) -- Shares of Rite Aid (RAD) are getting a bump Thursday morning following the release of better-than-expected fourth-quarter earnings.

The stock was up 29 cents, or 4.8%, at $6.40 early in Thursday's session.

This is welcome news to those shareholders who lived through a five-year period when the stock bounced between the $1 and $2 level before showing signs of life last April.

Following six consecutive years of losses, Rite Aid swung back to a small profit last year. Since then, shares have risen more than 250%, making this stock one of the big comeback stories of the past year.

Fiscal fourth-quarter revenue of $6.59 billion was just above the $6.54 billion consensus estimate, but adjusted earnings per share were 10 cents, easily topping the average analyst estimate of 4 cents, and that's what's driving the excitement Thursday.

The company indicated on Thursday's conference call that it is making the transition from turnaround to growth. That's what shareholders love to hear: crisis averted, moving on to bigger and better things.

As a deep value investor, I love turnaround stories. Rite Aid has fought a long uphill battle against bigger rivals CVS Caremark (CVS) and Walgreen (WAG). The problem, however, is that it appears the easy money has already been made here.

The concern that I have now is the company's debt load, which stood at nearly $5.7 billion at year-end, down from $5.9 billion last year. That translated into $425 million in interest expense for the year. That's a heavy burden to carry, especially for a company with $146 million in cash.

Debt is not necessarily a negative, but in this case, and at that level, it is constricting. When I see relatively large amounts of debt on a company's books, I also look for some corresponding assets that help backstop the debt. This can sometimes be found in the form of owned real estate. Unfortunately, in Rite Aid's case, more than 94% of the company's locations are leased.

At the end of last year, Rite Aid owned 260 of its locations, and 10 distribution centers. While that's a nice portfolio of real estate, it is not a backstop for $5.7 billion in debt. The company also carries a negative book value to the tune of $2.1 billion, and that also lowers my interest.

The company has big plans, and has made a nice comeback. The next leg up, however, may not be easy. Growth costs money, and the company already has too much debt.

Shareholders will bask today in the glow of a solid move to the upside. It's a great story, and those who hung in there after some dismal years are getting their payback.

At the time of publication, Heller had no positions in stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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