Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that The Providence Service Corporation (NASDAQ:PRSC) does have debt on its balance sheet. 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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Providence Service's Net Debt?
As you can see below, Providence Service had US$926.0k of debt at March 2019, down from US$2.36m a year prior. However, it does have US$42.4m in cash offsetting this, leading to net cash of US$41.5m.
A Look At Providence Service's Liabilities
According to the last reported balance sheet, Providence Service had liabilities of US$171.5m due within 12 months, and liabilities of US$49.6m due beyond 12 months. Offsetting these obligations, it had cash of US$42.4m as well as receivables valued at US$155.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$23.5m.
Given Providence Service has a market capitalization of US$701.2m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Providence Service also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Providence Service saw its EBIT drop by 4.5% in the last twelve months. 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 ultimately the future profitability of the business will decide if Providence Service can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Providence Service 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. Looking at the most recent three years, Providence Service recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Providence Service has US$41m in net cash. So we are not troubled with Providence Service's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Providence Service's earnings per share history for free.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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