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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 Myriad Genetics, Inc. (NASDAQ:MYGN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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, 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 Myriad Genetics’s Debt?
As you can see below, at the end of March 2019, Myriad Genetics had US$263.4m of debt, up from US$69.3m a year ago. Click the image for more detail. However, it also had US$149.7m in cash, and so its net debt is US$113.7m.
How Healthy Is Myriad Genetics’s Balance Sheet?
We can see from the most recent balance sheet that Myriad Genetics had liabilities of US$108.9m falling due within a year, and liabilities of US$366.7m due beyond that. On the other hand, it had cash of US$149.7m and US$147.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$178.9m.
Given Myriad Genetics has a market capitalization of US$2.00b, 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. Either way, since Myriad Genetics does have more debt than cash, it’s worth keeping an eye on its balance sheet.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
While Myriad Genetics’s low debt to EBITDA ratio of 0.97 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.93 last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. On the other hand, Myriad Genetics’s EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Myriad Genetics can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Myriad Genetics actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us excited like the crowd when the beat drops at a Daft Punk concert.
When it comes to the balance sheet, the standout positive for Myriad Genetics was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren’t so encouraging. In particular, EBIT growth rate gives us cold feet. When we consider all the elements mentioned above, it seems to us that Myriad Genetics is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you’ve also come to that realization, you’re in luck, because today you can view this interactive graph of Myriad Genetics’s earnings per share history for free.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.