Rite Aid – Reinitiating Coverage: Part 1

EXECUTIVE SUMMARY

• We are reinitiating coverage on Rite Aid (RAD) in a two part series. Rite Aid is a subscale retail pharmacy and pharmacy benefits manager (“PBM”) facing declining contributions from profitable COVID vaccines and looming opioid liability threats. In Part 1 of this report, we analyze Rite Aid’s two existing business segments, discuss its recent financial performance, analyze its capital structure, present a five-year projection model and discuss the potential for near-term future opioid liabilities. In Part 2 we will establish recovery value expectations and trade recommendations.
• Rite Aid has ambitious plan to right-size its business via SG&A cost cuts, targeted store closures and intentional culling of its unprofitable Part D insurance business. The Company anticipates FY2023 and ongoing SG&A cost savings of $145mn from its retail pharmacy segment and $25mn from its pharmacy services segment largely resulting from the closure of 145 retail store locations (expected to be fully completed in 2Q23).
• The Company is actively concentrated on reducing leverage both through normal course paydowns on its ABL revolver with FCF generation as well as pursuing distressed tender offers on its bonds. The Company recently repurchased $194mn of notional of three series of bonds for $150mn (22.5% discount to par).
• Management is targeting a mid-term net leverage goal of 4.5x in FY2025 down from 6.1x LTM (pro forma) due to EBITDA growth and use of FCF to pay down debt. We view this goal as overly optimistic, projecting instead a relatively deminimis leverage reduction resulting from flat EBITDA growth and minimal FCF generation, setting up a potentially challenging debt refinancing for the Company.
• Contributions from COVID vaccines and tests contributed an estimated $350mn of EBITDA to the Company at its peak in FY2022. Steep declines are anticipated going forward with management guiding to FY2023 vaccine volumes at only 20-30% of FY2022 levels.

BUSINESS SUMMARY

Rite Aid (RAD) is a US drugstore chain that operates within two segments: Retail pharmacy and pharmacy services. Through its 2,361 retail pharmacy locations, RAD dispenses medications, provides healthcare services such as immunizations, and provides a variety of front-end of store offerings (“FE”) in health & wellness and other consumables.

RAD’s pharmacy services segment includes its pharmacy benefit management (“PBM”) business (Elixir) as well as its Medicare Part D insurance business (Elixir Insurance). On a revenue basis, Rite Aid has traditionally had a roughly 70/30 split between its retail & pharmacy services segments from both a topline and Adj EBITDA perspective (although the pandemic era EBITDA mix was significantly impacted by a surge in vax and testing income).

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