Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Cross Country Healthcare, Inc. (NASDAQ:CCRN) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Cross Country Healthcare's Net Debt?
The image below, which you can click on for greater detail, shows that Cross Country Healthcare had debt of US$70.6m at the end of June 2019, a reduction from US$96.7m over a year. However, it also had US$24.8m in cash, and so its net debt is US$45.8m.
A Look At Cross Country Healthcare's Liabilities
According to the last reported balance sheet, Cross Country Healthcare had liabilities of US$94.1m due within 12 months, and liabilities of US$138.1m due beyond 12 months. On the other hand, it had cash of US$24.8m and US$150.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$56.9m.
Of course, Cross Country Healthcare has a market capitalization of US$396.9m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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.
While Cross Country Healthcare has a quite reasonable net debt to EBITDA multiple of 2.5, its interest cover seems weak, at 1.0. In large part that's it has so much depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) In any case, it's safe to say the company has meaningful debt. Importantly, Cross Country Healthcare's EBIT fell a jaw-dropping 79% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Cross Country Healthcare 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Cross Country Healthcare actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
We weren't impressed with Cross Country Healthcare's interest cover, and its EBIT growth rate made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble converting EBIT to free cash flow. We would also note that Healthcare industry companies like Cross Country Healthcare commonly do use debt without problems. Looking at all this data makes us feel a little cautious about Cross Country Healthcare's debt levels. 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 Cross Country Healthcare 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.
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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