Here's Why CRA International (NASDAQ:CRAI) Can Manage Its Debt Responsibly

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. Importantly, CRA International, Inc. (NASDAQ:CRAI) does carry debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for CRA International

What Is CRA International's Net Debt?

As you can see below, at the end of September 2020, CRA International had US$38.0m of debt, up from US$36.0m a year ago. Click the image for more detail. However, because it has a cash reserve of US$24.1m, its net debt is less, at about US$13.9m.

How Strong Is CRA International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CRA International had liabilities of US$197.2m due within 12 months and liabilities of US$148.6m due beyond that. Offsetting this, it had US$24.1m in cash and US$163.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$158.0m.

While this might seem like a lot, it is not so bad since CRA International has a market capitalization of US$432.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

CRA International's net debt is only 0.29 times its EBITDA. And its EBIT covers its interest expense a whopping 27.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that CRA International has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine CRA International's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, CRA International recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that CRA International's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. When we consider the range of factors above, it looks like CRA International is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for CRA International 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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