Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Heska Corporation (NASDAQ:HSKA) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Heska's Debt?
As you can see below, at the end of June 2019, Heska had US$12.8m of debt, up from US$6.02m a year ago. Click the image for more detail. On the flip side, it has US$9.99m in cash leading to net debt of about US$2.76m.
How Healthy Is Heska's Balance Sheet?
The latest balance sheet data shows that Heska had liabilities of US$15.4m due within a year, and liabilities of US$24.2m falling due after that. On the other hand, it had cash of US$9.99m and US$17.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$12.4m.
Since publicly traded Heska shares are worth a total of US$559.1m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Heska has virtually no net debt, so it's fair to say it does not have a heavy debt load!
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Heska has a low net debt to EBITDA ratio of only 0.26. And its EBIT covers its interest expense a whopping 245 times over. So we're pretty relaxed about its super-conservative use of debt. In fact Heska's saving grace is its low debt levels, because its EBIT has tanked 59% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Heska'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. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Heska's free cash flow amounted to 35% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Based on what we've seen Heska is not finding it easy EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to cover its interest expense with its EBIT is pretty flash. We would also note that Medical Equipment industry companies like Heska commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Heska's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. We'd be motivated to research the stock further if we found out that Heska insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.