Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that Universal Technical Institute, Inc. (NYSE:UTI) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Universal Technical Institute Carry?
The image below, which you can click on for greater detail, shows that at March 2022 Universal Technical Institute had debt of US$48.4m, up from none in one year. But on the other hand it also has US$61.5m in cash, leading to a US$13.1m net cash position.
How Healthy Is Universal Technical Institute's Balance Sheet?
The latest balance sheet data shows that Universal Technical Institute had liabilities of US$118.4m due within a year, and liabilities of US$188.3m falling due after that. On the other hand, it had cash of US$61.5m and US$21.0m worth of receivables due within a year. So it has liabilities totalling US$224.1m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$265.7m, so it does suggest shareholders should keep an eye on Universal Technical Institute's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Universal Technical Institute also has more cash than debt, so we're pretty confident it can manage its debt safely.
It was also good to see that despite losing money on the EBIT line last year, Universal Technical Institute turned things around in the last 12 months, delivering and EBIT of US$34m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Universal Technical Institute 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Universal Technical Institute has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last year, Universal Technical Institute burned a lot of cash. 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.
Although Universal Technical Institute's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$13.1m. So while Universal Technical Institute does not have a great balance sheet, it's certainly not too bad. 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. For example Universal Technical Institute has 2 warning signs (and 1 which is potentially serious) we think 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.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.