Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 LifeVantage Corporation (NASDAQ:LFVN) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is LifeVantage's Debt?
As you can see below, LifeVantage had US$1.45m of debt at June 2019, down from US$5.41m a year prior. But it also has US$18.8m in cash to offset that, meaning it has US$17.4m net cash.
How Healthy Is LifeVantage's Balance Sheet?
The latest balance sheet data shows that LifeVantage had liabilities of US$26.2m due within a year, and liabilities of US$1.88m falling due after that. Offsetting this, it had US$18.8m in cash and US$5.40m in receivables that were due within 12 months. So it has liabilities totalling US$3.85m more than its cash and near-term receivables, combined.
This state of affairs indicates that LifeVantage's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$209.4m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, LifeVantage boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that LifeVantage saw its EBIT decline by 4.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since LifeVantage will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While LifeVantage 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, LifeVantage 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.
We could understand if investors are concerned about LifeVantage's liabilities, but we can be reassured by the fact it has has net cash of US$17.4m. And it impressed us with free cash flow of US$15m, being 120% of its EBIT. So we don't think LifeVantage's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of LifeVantage's earnings per share history 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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