Fred's Deal With Walgreen's A Positive, But Price Spike Leaves Little Upside From Here

MKM Partners is positive on Fred's, Inc. FRED’s deal to buy 865 Rite Aid Corporation RAD stores for $950 million in cash as part of “forced divestiture” required by the FTC following Walgreens Boots Alliance Inc WBA’s acquisition of Rite Aid.

Why Sidelined?

But, the brokerage remains Neutral on Fred’s shares, as it believes the 81 percent surge in stock price has priced in much of the potential opportunity. It also sees a fair amount of integration risk, given Fred's poor operational performance.

Nevertheless, the deal will more than double Fred's size (currently 650 stores) and will make the company the third largest U.S. drugstore chain next to Walgreen's and CVS Health Corp CVS. Walgreen's, which operates nearly 13,000 stores globally, will add another 3,735 once it acquires Rite Aid, while CVS operates 9,700+ stores.

It's Definitely A Solid Deal

Analyst Patrick McKeever called Fred’s deal good, as it is effectively paying $1.1 million per store for stores that generate $5 million–$7 million in annual sales and $275,000–$300,000 in EBITDA.

“The mid-point of the EBITDA range implies a margin of 4.8 percent, well below the 7+ percent margins of Walgreens and CVS but dramatically above Fred's 1–2 percent rate,” McKeever wrote in a note.

McKeever expects the acquisition to produce about $300 million in EBITDA in year one, including $250 million from the Rite Aid stores and $50 million from Fred's assuming no major synergies.

As such, the analyst raised his fair value estimate on Fred’s shares to $22 from $9.

At last check, shares of Fred’s were down 1.44 percent at $19.90. Shares of Walgreen's were down 0.57 percent at $85.79, while Rite Aid shares were down 0.99 percent at $8.52.