David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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. Importantly, Computer Programs and Systems, Inc. (NASDAQ:CPSI) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Computer Programs and Systems's Debt?
The image below, which you can click on for greater detail, shows that Computer Programs and Systems had debt of US$129.7m at the end of June 2019, a reduction from US$139.0m over a year. On the flip side, it has US$6.85m in cash leading to net debt of about US$122.9m.
A Look At Computer Programs and Systems's Liabilities
Zooming in on the latest balance sheet data, we can see that Computer Programs and Systems had liabilities of US$43.0m due within 12 months and liabilities of US$134.9m due beyond that. On the other hand, it had cash of US$6.85m and US$51.0m worth of receivables due within a year. So its liabilities total US$120.1m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Computer Programs and Systems has a market capitalization of US$321.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Computer Programs and Systems's debt is 3.7 times its EBITDA, and its EBIT cover its interest expense 3.4 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. More concerning, Computer Programs and Systems saw its EBIT drop by 2.8% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. 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 Computer Programs and Systems'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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Computer Programs and Systems actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
On our analysis Computer Programs and Systems's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. We would also note that Healthcare Services industry companies like Computer Programs and Systems commonly do use debt without problems. Considering this range of data points, we think Computer Programs and Systems is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Computer Programs and Systems insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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