Rite Aid Leverages Bond Success in Turnaround: Corporate Finance

Jan. 17 (Bloomberg) — Three years after investors gave up on Rite Aid Corp., a plan by the third-largest U.S. pharmacy chain to extend debt maturities as it renovates stores is gaining the confidence of the credit market.

Yields on the retailer’s bonds have fallen to an average of 8.6 percent, from 23.9 percent three years ago, as Rite Aid arranged about $3.5 billion of new debt and credit lines over the period, according to data compiled by Bloomberg. The company’s $295 million of 7.7 percent notes due in February 2027 have returned about 38 percent in the past year, beating the 24 percent gain in the company’s stock price and topping the 4.1 percent average return on speculative-grade debt securities.

Chief Executive John Standley, 48, who took over in 2010, is leveraging his success in the bond market to gain more time to execute his plan to capture market share from competitors Walgreen Co. and CVS Caremark Corp. The Camp Hill, Pennsylvania- based drug-store operator’s sales have climbed for nine straight months as a new rewards program draws repeat business.

“It was a ‘show-me’ story when the new management came in, and now you’ve seen the turnaround starting,” Stefan Lingmerth, an analyst for Phoenix Investment Adviser LLC in New York, said in a telephone interview. “As soon as they came in, they started addressing the liquidity and the capital structure.”

Default Swaps

Bond investors are gaining comfort they’ll be repaid. Credit-default swaps on Rite Aid imply a 46 percent chance the company will default on its debts within five years, down from 99 percent in March 2009, according to a standard pricing model maintained by data provider CMA.

“Everybody was convinced they were going to file for bankruptcy and they didn’t,” said Maggie Taylor, who tracks the company for Moody’s Investors Service. “You are starting to see in their earnings some very modest improvement.”

Moody’s rates Rite Aid at Caa2, two levels below Standard Poor’s B- rating. The company, which has about $6.2 billion of long-term debt, is among the 50 largest junk-bond issuers in the U.S., Bank of America Merrill Lynch index data show.

Rite Aid ran into trouble after buying about 1,850 Brooks and Eckerd stores in 2007, paying about $2.4 billion in cash just as the economy was going into recession, according to a regulatory filing.

Rising Leverage

The company’s leverage, or ratio of debt to earnings before interest, taxes, depreciation and amortization, soared to 32.3 times in March 2008 from 9 a year earlier, as long-term obligations almost doubled to $5.8 billion, Bloomberg data show.

Standley was appointed president of Rite Aid in September 2008 and took over as CEO in June 2010.

At the end of 2009, Rite Aid faced about $6 billion of bonds, loans and credit lines that would mature before 2015, Bloomberg data show. While the company has cut that amount to $1.2 billion by issuing bonds and arranging new bank loans, leverage came down to about 9 times as of Nov. 26, still higher than Walgreen’s at 0.5 and CVS at 1.4.

“Rite Aid has always been able to handle its maturities, but they still are very highly leveraged,” Taylor said. “Their interest burden is so high they’re very constrained in what they can invest.”

The company paid $524 million in interest over the 12 months through November, about double its $265.4 million of operating income, Bloomberg data show.

‘Disappointing’ Sales

“Sales and earnings have been disappointing and the only good news is that recent refinancings are keeping the company liquid and extending debt maturities,” analysts at debt research firm Gimme Credit LLC said in a Jan. 6 report.

Forty-seven million customers have signed up for Rite Aid’s “wellness+” rewards card since it was created in 2010, Standley told analysts on a Dec. 15 conference call. Rite Aid plans to spend $115 million in the 12 months ending in March building new stores while remodeling and moving others, it said in its latest quarterly report.