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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. Importantly, Molina Healthcare, Inc. (NYSE:MOH) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Molina Healthcare Carry?
The chart below, which you can click on for greater detail, shows that Molina Healthcare had US$1.26b in debt in December 2019; about the same as the year before. However, its balance sheet shows it holds US$4.40b in cash, so it actually has US$3.14b net cash.
A Look At Molina Healthcare's Liabilities
Zooming in on the latest balance sheet data, we can see that Molina Healthcare had liabilities of US$3.27b due within 12 months and liabilities of US$1.56b due beyond that. On the other hand, it had cash of US$4.40b and US$1.41b worth of receivables due within a year. So it actually has US$977.0m more liquid assets than total liabilities.
This surplus suggests that Molina Healthcare has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Molina Healthcare boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Molina Healthcare's EBIT dived 12%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Molina Healthcare can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Molina Healthcare 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. In the last three years, Molina Healthcare's free cash flow amounted to 31% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While we empathize with investors who find debt concerning, you should keep in mind that Molina Healthcare has net cash of US$3.14b, as well as more liquid assets than liabilities. So we are not troubled with Molina Healthcare's debt use. 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. To that end, you should be aware of the 1 warning sign we've spotted with Molina Healthcare .
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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