Is Allied Healthcare Products (NASDAQ:AHPI) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Allied Healthcare Products, Inc. (NASDAQ:AHPI) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Allied Healthcare Products

How Much Debt Does Allied Healthcare Products Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Allied Healthcare Products had US$3.84m of debt, an increase on none, over one year. However, it does have US$276.5k in cash offsetting this, leading to net debt of about US$3.56m.

How Healthy Is Allied Healthcare Products' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Allied Healthcare Products had liabilities of US$8.87m due within 12 months and liabilities of US$144.7k due beyond that. Offsetting these obligations, it had cash of US$276.5k as well as receivables valued at US$3.18m due within 12 months. So it has liabilities totalling US$5.57m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Allied Healthcare Products has a market capitalization of US$15.2m, 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). 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).

Allied Healthcare Products has net debt to EBITDA of 2.8 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 7.1 suggests it can easily service that debt. Notably, Allied Healthcare Products made a loss at the EBIT level, last year, but improved that to positive EBIT of US$680k in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Allied Healthcare Products will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Allied Healthcare Products burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Allied Healthcare Products's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to to cover its interest expense with its EBIT isn't too shabby at all. We should also note that Medical Equipment industry companies like Allied Healthcare Products commonly do use debt without problems. When we consider all the factors discussed, it seems to us that Allied Healthcare Products is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. For example Allied Healthcare Products has 4 warning signs (and 1 which shouldn't be ignored) 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.

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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. 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.
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