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'. 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. We can see that Healthcare Services Group, Inc. (NASDAQ:HCSG) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Healthcare Services Group Carry?
The image below, which you can click on for greater detail, shows that Healthcare Services Group had debt of US$10.0m at the end of December 2019, a reduction from US$30.0m over a year. However, its balance sheet shows it holds US$118.0m in cash, so it actually has US$108.0m net cash.
How Strong Is Healthcare Services Group's Balance Sheet?
We can see from the most recent balance sheet that Healthcare Services Group had liabilities of US$148.7m falling due within a year, and liabilities of US$113.6m due beyond that. Offsetting this, it had US$118.0m in cash and US$340.9m in receivables that were due within 12 months. So it actually has US$196.7m more liquid assets than total liabilities.
This short term liquidity is a sign that Healthcare Services Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Healthcare Services Group boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Healthcare Services Group if management cannot prevent a repeat of the 20% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Healthcare Services Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Healthcare Services Group 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. Over the most recent three years, Healthcare Services Group recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While we empathize with investors who find debt concerning, you should keep in mind that Healthcare Services Group has net cash of US$108.0m, as well as more liquid assets than liabilities. So we don't have any problem with Healthcare Services Group's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Healthcare Services Group is showing 2 warning signs in our investment analysis , you should know about...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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