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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. We note that Adtalem Global Education Inc. (NYSE:ATGE) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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. 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.
How Much Debt Does Adtalem Global Education Carry?
As you can see below, Adtalem Global Education had US$296.7m of debt at December 2020, down from US$415.1m a year prior. However, it does have US$449.3m in cash offsetting this, leading to net cash of US$152.6m.
How Strong Is Adtalem Global Education's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Adtalem Global Education had liabilities of US$340.7m due within 12 months and liabilities of US$587.5m due beyond that. Offsetting this, it had US$449.3m in cash and US$96.2m in receivables that were due within 12 months. So its liabilities total US$382.8m more than the combination of its cash and short-term receivables.
Of course, Adtalem Global Education has a market capitalization of US$1.96b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Adtalem Global Education also has more cash than debt, so we're pretty confident it can manage its debt safely.
Also positive, Adtalem Global Education grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Adtalem Global Education can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Adtalem Global 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. During the last three years, Adtalem Global Education produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Although Adtalem Global Education's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$152.6m. And we liked the look of last year's 29% year-on-year EBIT growth. So we don't think Adtalem Global Education's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Adtalem Global Education has 1 warning sign we think you should be aware of.
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.
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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