These 4 Measures Indicate That Allied Healthcare Products (NASDAQ:AHPI) Is Using Debt Extensively

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. Importantly, Allied Healthcare Products, Inc. (NASDAQ:AHPI) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for Allied Healthcare Products

What Is Allied Healthcare Products's Debt?

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, because it has a cash reserve of US$276.5k, its net debt is less, at about US$3.56m.

How Healthy Is Allied Healthcare Products' Balance Sheet?

We can see from the most recent balance sheet that Allied Healthcare Products had liabilities of US$8.87m falling due within a year, and liabilities of US$144.7k due beyond that. Offsetting this, it had US$276.5k in cash and US$3.18m in receivables that were due within 12 months. So its liabilities total US$5.57m more than the combination of its cash and short-term receivables.

Given Allied Healthcare Products has a market capitalization of US$36.5m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

With net debt to EBITDA of 2.8 Allied Healthcare Products has a fairly noticeable amount of debt. But the high interest coverage of 7.1 suggests it can easily service that debt. We also note that Allied Healthcare Products improved its EBIT from a last year's loss to a positive US$680k. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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 struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to cover its interest expense with its EBIT isn't too shabby at all. It's also worth noting that Allied Healthcare Products is in the Medical Equipment industry, which is often considered to be quite defensive. We think that Allied Healthcare Products's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Allied Healthcare Products you should be aware of, and 1 of them is a bit concerning.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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