Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that Rite Aid Corporation (NYSE: RAD) uses debt in its business. But the most important question is: what risk does this debt create?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest review for Rite Aid
What is Rite Aid’s debt?
As you can see below, Rite Aid was in debt of US $ 3.01 billion in May 2021, up from US $ 3.32 billion the year before. However, given that it has a cash reserve of US $ 118.5 million, its net debt is less, at around US $ 2.90 billion.
A look at the responsibilities of Rite Aid
According to the latest published balance sheet, Rite Aid had liabilities of US $ 2.74 billion due within 12 months and liabilities of US $ 6.01 billion due beyond 12 months. In compensation for these obligations, he had cash of US $ 118.5 million as well as receivables valued at US $ 1.61 billion due within 12 months. Its liabilities therefore total US $ 7.02 billion more than the combination of its cash and short-term receivables.
The lack here weighs heavily on the $ 936.3 million business itself, as if a child struggles under the weight of a huge backpack full of books, his gym equipment and a trumpet. . So we would be watching its record closely, without a doubt. Ultimately, Rite Aid would likely need a major recapitalization if its creditors demanded repayment.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Rite Aid shareholders face the double whammy of a high net debt / EBITDA ratio (6.1) and relatively low interest coverage, since EBIT is only 0.77 times expenses of interest. This means that we would consider him to be in heavy debt. Worse yet, Rite Aid has seen its EBIT reach 34% over the past 12 months. If profits continue to follow this path, it will be more difficult to pay off this debt than to convince us to run a marathon in the rain. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the future profitability of the business will decide whether Rite Aid can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Rite Aid has spent a lot of money. While this may be the result of spending on growth, it makes debt much riskier.
Our point of view
To be frank, Rite Aid’s EBIT growth rate and its history of staying above its total liabilities make us rather uncomfortable with its debt levels. And what’s more, his interest coverage fails to inspire confidence either. It seems to us that Rite Aid carries a significant financial burden. If you harvest honey without a bee costume, you might get stung, so we’ll likely stay away from that particular stock. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you should inquire about the 4 warning signs we spotted with Rite Aid (2 of which are potentially serious).
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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