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 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 U.S. Physical Therapy, Inc. (NYSE:USPH) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is U.S. Physical Therapy's Net Debt?
You can click the graphic below for the historical numbers, but it shows that U.S. Physical Therapy had US$25.4m of debt in September 2020, down from US$56.0m, one year before. However, it does have US$30.1m in cash offsetting this, leading to net cash of US$4.70m.
A Look At U.S. Physical Therapy's Liabilities
Zooming in on the latest balance sheet data, we can see that U.S. Physical Therapy had liabilities of US$93.2m due within 12 months and liabilities of US$76.6m due beyond that. Offsetting this, it had US$30.1m in cash and US$49.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$90.3m.
Given U.S. Physical Therapy has a market capitalization of US$1.55b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, U.S. Physical Therapy also has more cash than debt, so we're pretty confident it can manage its debt safely.
It is just as well that U.S. Physical Therapy's load is not too heavy, because its EBIT was down 20% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if U.S. Physical Therapy 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While U.S. Physical Therapy 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. Happily for any shareholders, U.S. Physical Therapy actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to look at a company's total liabilities, it is very reassuring that U.S. Physical Therapy has US$4.70m in net cash. And it impressed us with free cash flow of US$82m, being 112% of its EBIT. So we don't have any problem with U.S. Physical Therapy's use of debt. 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. Case in point: We've spotted 2 warning signs for U.S. Physical Therapy you should be aware of.
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.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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