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. Importantly, CryoLife, Inc. (NYSE:CRY) does carry debt. But the more important question is: how much risk is that debt creating?
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, 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 CryoLife's Debt?
The chart below, which you can click on for greater detail, shows that CryoLife had US$216.2m in debt in June 2019; about the same as the year before. However, it does have US$39.7m in cash offsetting this, leading to net debt of about US$176.4m.
A Look At CryoLife's Liabilities
We can see from the most recent balance sheet that CryoLife had liabilities of US$37.5m falling due within a year, and liabilities of US$277.5m due beyond that. Offsetting these obligations, it had cash of US$39.7m as well as receivables valued at US$61.7m due within 12 months. So its liabilities total US$213.5m more than the combination of its cash and short-term receivables.
Of course, CryoLife has a market capitalization of US$1.11b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Weak interest cover of 1.1 times and a disturbingly high net debt to EBITDA ratio of 5.6 hit our confidence in CryoLife like a one-two punch to the gut. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that CryoLife actually grew its EBIT by a hefty 177%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CryoLife 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. So we always check how much of that EBIT is translated into free cash flow. In the last three years, CryoLife's free cash flow amounted to 42% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
We weren't impressed with CryoLife's net debt to EBITDA, and its interest cover made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble growing its EBIT. It's also worth noting that CryoLife is in the Medical Equipment industry, which is often considered to be quite defensive. Considering this range of data points, we think CryoLife is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that CryoLife insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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