U.S. Markets closed

Is LHC Group (NASDAQ:LHCG) Using Too Much Debt?

Simply Wall St

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that LHC Group, Inc. (NASDAQ:LHCG) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for LHC Group

What Is LHC Group's Debt?

As you can see below, LHC Group had US$230.0m of debt at June 2019, down from US$254.9m a year prior. On the flip side, it has US$26.7m in cash leading to net debt of about US$203.3m.

NasdaqGS:LHCG Historical Debt, August 26th 2019

A Look At LHC Group's Liabilities

The latest balance sheet data shows that LHC Group had liabilities of US$224.8m due within a year, and liabilities of US$341.6m falling due after that. On the other hand, it had cash of US$26.7m and US$280.1m worth of receivables due within a year. So it has liabilities totalling US$259.5m more than its cash and near-term receivables, combined.

Given LHC Group has a market capitalization of US$3.75b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

LHC Group has a low net debt to EBITDA ratio of only 1.0. And its EBIT easily covers its interest expense, being 17.0 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, LHC Group grew its EBIT by 139% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if LHC Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, LHC Group produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

LHC Group's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. We would also note that Healthcare industry companies like LHC Group commonly do use debt without problems. Looking at the bigger picture, we think LHC Group's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. Another factor that would give us confidence in LHC Group would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.