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. 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, BioTelemetry, Inc. (NASDAQ:BEAT) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
What Is BioTelemetry’s Net Debt?
The chart below, which you can click on for greater detail, shows that BioTelemetry had US$194.7m in debt in December 2019; about the same as the year before. However, because it has a cash reserve of US$68.6m, its net debt is less, at about US$126.1m.
A Look At BioTelemetry’s Liabilities
Zooming in on the latest balance sheet data, we can see that BioTelemetry had liabilities of US$55.8m due within 12 months and liabilities of US$263.0m due beyond that. Offsetting these obligations, it had cash of US$68.6m as well as receivables valued at US$87.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$162.7m.
Given BioTelemetry has a market capitalization of US$984.3m, 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.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While BioTelemetry’s low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.8 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. While BioTelemetry doesn’t seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if BioTelemetry 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, BioTelemetry produced sturdy free cash flow equating to 60% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
We feel that BioTelemetry’s solid conversion of EBIT to free cash flow was really heart warming, like a mid-winter fair trade hot chocolate in a tasteful alpine chalet. And its net debt to EBITDA should also leave shareholders feeling frolicsome. We would also note that Healthcare industry companies like BioTelemetry commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that BioTelemetry can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it’s worth monitoring the balance sheet. 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, we’ve discovered 5 warning signs for BioTelemetry that you should be aware of before investing here.
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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