Warren Buffett famously said, ‘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. As with many other companies Invacare Corporation (NYSE:IVC) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
Check out our latest analysis for Invacare
How Much Debt Does Invacare Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Invacare had US$242.3m of debt, an increase on US$222.3m, over one year. However, because it has a cash reserve of US$86.8m, its net debt is less, at about US$155.4m.
A Look At Invacare’s Liabilities
We can see from the most recent balance sheet that Invacare had liabilities of US$233.3m falling due within a year, and liabilities of US$380.1m due beyond that. Offsetting these obligations, it had cash of US$86.8m as well as receivables valued at US$134.9m due within 12 months. So it has liabilities totalling US$391.7m more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company’s market capitalization of US$346.5m, we think shareholders really should watch Invacare’s debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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 0.40 times and a disturbingly high net debt to EBITDA ratio of 6.1 hit our confidence in Invacare like a one-two punch to the gut. This means we’d consider it to have a heavy debt load. One redeeming factor for Invacare is that it turned last year’s EBIT loss into a gain of US$11m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Invacare 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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Invacare saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
On the face of it, Invacare’s interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. It’s also worth noting that Invacare is in the Medical Equipment industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think Invacare has too much debt. While some investors love that sort of risky play, it’s certainly not our cup of tea. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Be aware that Invacare is showing 2 warning signs in our investment analysis , you should know about…
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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