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, Allscripts Healthcare Solutions, Inc. (NASDAQ:MDRX) does carry debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Allscripts Healthcare Solutions Carry?
You can click the graphic below for the historical numbers, but it shows that Allscripts Healthcare Solutions had US$844.8m of debt in June 2019, down from US$1.65b, one year before. However, it does have US$138.9m in cash offsetting this, leading to net debt of about US$705.9m.
A Look At Allscripts Healthcare Solutions's Liabilities
The latest balance sheet data shows that Allscripts Healthcare Solutions had liabilities of US$879.8m due within a year, and liabilities of US$1.04b falling due after that. Offsetting this, it had US$138.9m in cash and US$503.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.28b.
This deficit is considerable relative to its market capitalization of US$1.56b, so it does suggest shareholders should keep an eye on Allscripts Healthcare Solutions's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Weak interest cover of 0.59 times and a disturbingly high net debt to EBITDA ratio of 6.1 hit our confidence in Allscripts Healthcare Solutions like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Allscripts Healthcare Solutions is that it turned last year's EBIT loss into a gain of US$28m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Allscripts Healthcare Solutions 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Allscripts Healthcare Solutions saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
On the face of it, Allscripts Healthcare Solutions's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. It's also worth noting that Allscripts Healthcare Solutions is in the Healthcare Services industry, which is often considered to be quite defensive. We're quite clear that we consider Allscripts Healthcare Solutions to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. Given our concerns about Allscripts Healthcare Solutions's debt levels, it seems only prudent to check if insiders have been ditching the stock.
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.
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