David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Acadia Healthcare Company, Inc. (NASDAQ:ACHC) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
How Much Debt Does Acadia Healthcare Company Carry?
As you can see below, Acadia Healthcare Company had US$3.25b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. And it doesn't have much cash, so its net debt is about the same.
A Look At Acadia Healthcare Company's Liabilities
We can see from the most recent balance sheet that Acadia Healthcare Company had liabilities of US$430.7m falling due within a year, and liabilities of US$3.91b due beyond that. Offsetting this, it had US$43.5m in cash and US$389.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.90b.
This deficit casts a shadow over the US$2.44b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, Acadia Healthcare Company would likely require a major re-capitalisation if it had to pay its creditors today.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Weak interest cover of 2.1 times and a disturbingly high net debt to EBITDA ratio of 5.7 hit our confidence in Acadia Healthcare Company like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even more troubling is the fact that Acadia Healthcare Company actually let its EBIT decrease by 9.4% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Acadia Healthcare Company 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Acadia Healthcare Company created free cash flow amounting to 19% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
To be frank both Acadia Healthcare Company's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its EBIT growth rate also fails to instill confidence. We should also note that Healthcare industry companies like Acadia Healthcare Company commonly do use debt without problems. After considering the datapoints discussed, we think Acadia Healthcare Company has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Even though Acadia Healthcare Company lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending over the last few years.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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