Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, National HealthCare Corporation (NYSEMKT:NHC) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is National HealthCare's Net Debt?
You can click the graphic below for the historical numbers, but it shows that National HealthCare had US$79.9m of debt in March 2019, down from US$125.8m, one year before. However, it does have US$185.3m in cash offsetting this, leading to net cash of US$105.4m.
A Look At National HealthCare's Liabilities
The latest balance sheet data shows that National HealthCare had liabilities of US$170.0m due within a year, and liabilities of US$391.6m falling due after that. Offsetting these obligations, it had cash of US$185.3m as well as receivables valued at US$102.0m due within 12 months. So it has liabilities totalling US$274.3m more than its cash and near-term receivables, combined.
National HealthCare has a market capitalization of US$1.32b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, National HealthCare boasts net cash, so it's fair to say it does not have a heavy debt load!
National HealthCare's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is National HealthCare's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While National HealthCare has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, National HealthCare generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While National HealthCare does have more liabilities than liquid assets, it also has net cash of US$105m. And it impressed us with free cash flow of US$68m, being 85% of its EBIT. So we don't think National HealthCare's use of debt is risky. We'd be motivated to research the stock further if we found out that National 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.
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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