The balance sheet isn't the most exciting way for investors to evaluate a company, but it's still vitally important because the financial health of a company like Rite Aid (NYSE:RAD) can make or break your investment.
Since Rite Aid shares have tumbled following a horrendous quarterly report, this is the perfect time to look at the financials behind the pharmacy chain's story to see if there's a reason to buy.
Why does a balance sheet matter?
I think it's best to think of a balance sheet as a building's foundation. The better the foundation, the better the building.
If a company has a good balance sheet, it can go to the financial markets and borrow money at cheap rates, or it can raise money by offering additional stock. If it has a bad balance sheet, banks won't lend and investors won't buy.
In this way, balance sheets show you how likely a company is to take advantage of an opportunity. It tells you if a company has the firepower to make acquisitions, move into new markets, or hire more people.
How do you determine if a balance sheet is good or bad? In the simplest terms, a balance sheet can be considered good when assets, such as cash, are nicely higher than liabilities, such as loans from banks.
How does Rite Aid stack up?
Sadly for bulls, Rite Aid's balance sheet remains worrisome. Rite Aid took on a big chunk of debt heading into the recession when it bought the Eckerd pharmacy chain, and the company has struggled ever since to regain its footing.
Even after closing stores and refinancing debt to return to profitability, Rite Aid's debt to assets ratio (long- and short-term debt divided by cash and other assets) still stands at 87%. By comparing the retailer on this measure to CVS, which has a debt to assets ratio of 18.4%, and Walgreen, which has a debt to assets ratio of 12.1%, you can see just how financially stretched Rite Aid is.
Looking at it another way, if Rite Aid liquidated all its existing assets, including cash and inventory, it still could not cover the amount it owes in long-term debt.
Although that's a bit scary, there are some encouraging signs on the balance sheet that investors can rally behind. For example, Rite Aid's cash and equivalents, or money that can be easily tapped, has climbed from less than $125 million in 2013 to $185 million. Meanwhile, the company's long-term debt fell from a peak of over $6 billion last year to less than $5.6 billion in the last quarter.
Continuing to continue
Rite Aid's suspect balance sheet probably isn't too surprising to most of the company's investors. After all, the company's share price was hovering near $1 per share not that long ago over concerns that it would never get back on track. So, Rite Aid investors tend to focus less on the absolute numbers on the balance sheet and more on their trends.
Investors should typically avoid that kind of thinking, but in Rite Aid's case many intriguing catalysts could support growth in the coming years, including aging baby boomers' increasing demand for prescription drugs, rising insurance enrollment tied to healthcare reform, and the potential to provide more healthcare services through in-store retail clinics. For those reasons, investors considering Rite Aid might want to keep an eye on the balance sheet each quarter to make sure cash and debt are trending the right way. Regardless, the balance sheet suggests Rite Aid is only suitable for the most risk-tolerant of investors.
Todd Campbell is long Rite Aid. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.