Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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. We can see that HMS Holdings Corp. (NASDAQ:HMSY) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does HMS Holdings Carry?
The chart below, which you can click on for greater detail, shows that HMS Holdings had US$240.0m in debt in September 2019; about the same as the year before. However, it does have US$280.6m in cash offsetting this, leading to net cash of US$40.6m.
How Healthy Is HMS Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that HMS Holdings had liabilities of US$76.0m due within 12 months and liabilities of US$286.9m due beyond that. Offsetting this, it had US$280.6m in cash and US$206.3m in receivables that were due within 12 months. So it can boast US$124.1m more liquid assets than total liabilities.
This surplus suggests that HMS Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, HMS Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that HMS Holdings has boosted its EBIT by 41%, thus reducing the spectre of future debt repayments. 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 HMS Holdings'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 company can only pay off debt with cold hard cash, not accounting profits. While HMS Holdings 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 last three years, HMS Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company's debt, in this case HMS Holdings has US$40.6m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in US$126m. When it comes to HMS Holdings's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. For example, we've discovered 1 warning sign for HMS Holdings that you should be aware of before investing here.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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