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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.' 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 Evolent Health, Inc. (NYSE:EVH) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Evolent Health's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Evolent Health had US$285.2m of debt, an increase on US$228.0m, over one year. However, it does have US$375.2m in cash offsetting this, leading to net cash of US$90.0m.
A Look At Evolent Health's Liabilities
According to the last reported balance sheet, Evolent Health had liabilities of US$365.5m due within 12 months, and liabilities of US$371.5m due beyond 12 months. On the other hand, it had cash of US$375.2m and US$96.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$265.9m.
Since publicly traded Evolent Health shares are worth a total of US$1.57b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Evolent Health boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Evolent Health 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.
Over 12 months, Evolent Health reported revenue of US$987m, which is a gain of 23%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.
So How Risky Is Evolent Health?
Statistically speaking companies that lose money are riskier than those that make money. And in the last year Evolent Health had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through US$25m of cash and made a loss of US$518m. Given it only has net cash of US$90.0m, the company may need to raise more capital if it doesn't reach break-even soon. With very solid revenue growth in the last year, Evolent Health may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Evolent Health has 2 warning signs we think you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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