Akumin (TSE:AKU) Use Of Debt Could Be Considered Risky

By
Simply Wall St
Published
May 13, 2021
TSX:AKU
Source: Shutterstock

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 note that Akumin Inc. (TSE:AKU) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Akumin

How Much Debt Does Akumin Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Akumin had US$390.0m of debt, an increase on US$341.1m, over one year. On the flip side, it has US$44.4m in cash leading to net debt of about US$345.6m.

debt-equity-history-analysis
TSX:AKU Debt to Equity History May 14th 2021

How Healthy Is Akumin's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Akumin had liabilities of US$51.9m due within 12 months and liabilities of US$527.0m due beyond that. On the other hand, it had cash of US$44.4m and US$91.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$443.4m.

The deficiency here weighs heavily on the US$214.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Akumin would probably need a major re-capitalization if its creditors were to demand repayment.

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).

Weak interest cover of 0.79 times and a disturbingly high net debt to EBITDA ratio of 7.5 hit our confidence in Akumin like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Akumin saw its EBIT tank 37% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Akumin 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, 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, Akumin reported free cash flow worth 12% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

To be frank both Akumin's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its net debt to EBITDA also fails to instill confidence. We should also note that Healthcare industry companies like Akumin commonly do use debt without problems. Considering all the factors previously mentioned, we think that Akumin really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. Be aware that Akumin is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

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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