These 4 Measures Indicate That Grand Canyon Education (NASDAQ:LOPE) Is Using Debt Reasonably Well
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Grand Canyon Education, Inc. (NASDAQ:LOPE) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Grand Canyon Education
What Is Grand Canyon Education's Debt?
The image below, which you can click on for greater detail, shows that Grand Canyon Education had debt of US$116.1m at the end of September 2020, a reduction from US$256.4m over a year. However, its balance sheet shows it holds US$179.8m in cash, so it actually has US$63.7m net cash.
How Healthy Is Grand Canyon Education's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Grand Canyon Education had liabilities of US$122.7m due within 12 months and liabilities of US$156.9m due beyond that. Offsetting these obligations, it had cash of US$179.8m as well as receivables valued at US$98.0m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
Having regard to Grand Canyon Education's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$3.99b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Grand Canyon Education also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the other side of the story is that Grand Canyon Education saw its EBIT decline by 2.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Grand Canyon Education's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Grand Canyon Education may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Grand Canyon Education's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Grand Canyon Education has US$63.7m in net cash. So we are not troubled with Grand Canyon Education's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Grand Canyon Education that you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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