The quarterly performance and key developments of a company is what drives the short-term direction of its stock. A company's short-term catalysts can create a boost of excitement and lead to excessive gains for those who invest at the right time. However, for long-term investors, there is often more to the story than the headlines from a quarterly report. A company can often dig a hole so deep that in spite of quarterly performance and a bright future, the company may still fail due to its past. In this article, I am looking at several companies that have shown signs of short-term upside, yet are still left with mounting debt and a troubled balance sheet that must be addressed. Each of these companies could overcome the issues but it will not be done overnight.
Sprint Nextel (S)
The first company has made the S&P 500's 16.5% 2012 gains look frail due to its 125% increase in value, Sprint Nextel. Sprint has rallied higher after seeing a truly incredible change of its business. Prior to 2012, the company had traded with massive loss following years of declining fundamentals and falling subscribers. However, in its new "iPhone era," the company has been able to post subscriber growth and announce substantial improvements to its year-over-year performance in terms of sales. With the iPhone 5 having sold two million units on day one of its pre-order sales, it seems likely that Sprint's rally and its fundamental growth will continue. The problem is that Sprint must soon see profit, its balance sheet remains dismal, and after several years of fundamental hardships, the company needs to see continued growth in order to maintain its story of success.
Despite Sprint's quarterly improvements and the fact that it has posted subscriber and revenue growth, the company does not have the fundamental leverage to continue operating with such large loss. The company has a debt-to-assets ratio of 43% which has consistently increased over the last five years, and is significantly higher than competitors Verizon (VZ) and AT&T (T). The company's total debt is in excess of $21 billion and the company has an accumulated deficit of $42.726 billion (which also continues to rise). In other words, Sprint has as much debt as Apple (AAPL) has cash. Sprint has put itself in a bad situation, but on the bright side, it does have operating cash flow of $3.85 billion, showing that its turnaround is very possible. The good news is that the iPhone is a company changing device and Sprint has several advantages over its competitors. This year will be crucial for Sprint as it needs to move forward and improve its fundamentals to a larger degree, and erase some its mounting debt.
Clearwire is a company that has underperformed the market in 2012, but has increased in value by 50% over the last two months due to the performance of Sprint. Clearwire has a long lasting relationship with Sprint, and in the past has been reliant on Sprint for its mere survival. Clearwire is still somewhat dependent on Sprint but recently added several new wholesale partnerships with companies such as Leap Wireless (LEAP) and EarthLink (ELNK), therefore easing some of its dependence. Yet despite its promise, the company still has the burden of excess debt and margins that make upside difficult to find. Clearwire is a company with a debt-to-assets ratio over 50%, a ratio that has risen steadily since 2007. The company is much smaller than Sprint, therefore its $4 billion in debt may not look bad considering Sprint's $21 billion but these are two completely different companies. In some ways, I think Clearwire has a longer road with a $932 million loss in operating cash flow. However, the company does have good prospects in the form of new partnerships that could reverse its bad fundamental fortunes. The first step will be positive operating cash flow, and until this occurs, the fundamentals of the company will become worse, regardless of its upside.
Rite Aid (RAD)
Rite Aid is a stock that recently started to show some signs of life following very modest gains in 2012. After several years of loss, and declining sales, the company recently posted modest gains in revenue year-over-year. The company's growth is small, just 1.20% last quarter, but is still an improvement compared to the previous three years. Some investors have begun to suggest that Rite Aid may be a good turnaround story, which is possible, but the company has a long road ahead. The company has the largest amount of debt-to-assets of any company on this list, with over 85% and more than $6.3 billion being debt. The company is much larger than it appears, with over $26 billion in sales, yet trades with a market cap of $1.2 billion. Therefore, sales are not the issue, it's the margins. Rite Aid's margins have stayed consistent but the company doesn't have the financial leverage to take chances to improve its financial condition. It has an accumulated deficit of nearly $8 billion yet loses most of its money from financing and investing activities. Overall, the company has shown some promise, but if I were an investor in RAD, I'd be much less concerned with its revenue/sales growth and more concerned with how the company plans to increase margins and become profitable. Much like the others on this list, the turnaround won't be overnight. Yet because RAD is a company that is near "break-even' in terms of profit, it's possible that it could make minor changes to improve its business structure. Hopefully, the company can determine these "minor changes" before its financial situation worsens, which is possible.
Level 3 Communications (LVLT)
Level 3 is a company with great promise that has increased in value by 42% this year alone. The company's acquisition of Global Crossing has great synergy and has significantly improved the businesses' margins, as the company's operating margins are positive. This is a company that should have filed for bankruptcy many times over and has prevailed time-after-time. Yet due to mistakes of the past and very precise accounting, the company continues to move forward and is left with significant debt and a Global Crossing acquisition that must pay off and return profitability in the near future. Following the Global Crossing acquisition, Level 3 now has nearly $8.5 billion in debt and a debt-to-assets ratio of almost 65%. The company's years of loss have impacted its financial health and created an accumulated deficit of $12.6 billion. As the company moves forward, this debt will become a major burden and the company will have to find a way to become profitable on a consistent basis to cut additional expenditures so that it can continue to grow.
Each of these companies show great promise of growth and large returns but must address the issue of mounting debt to experience continued growth. The solution to the problems of high debt, accumulated loss, and negative cash flow are fundamental metrics that should be weighed accordingly, more so than top- and bottom-line performance. When due diligence is being performed, the fundamental question that all investors should ask when looking at a company with mounting debt is, "How can the company erase the debt?" Sometimes the solution is simple and sometimes it is not. Either way, the answer should be weighed greatly and should aid in determining the long-term outlook of a company, more so than any other factor.
All fundamental data was obtained from Google Finance
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.