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 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 note that Change Healthcare Inc. (NASDAQ:CHNG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Change Healthcare Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Change Healthcare had US$4.85b of debt, an increase on US$39.0m, over one year. On the flip side, it has US$137.4m in cash leading to net debt of about US$4.71b.
How Healthy Is Change Healthcare's Balance Sheet?
According to the last reported balance sheet, Change Healthcare had liabilities of US$1.04b due within 12 months, and liabilities of US$5.88b due beyond 12 months. Offsetting these obligations, it had cash of US$137.4m as well as receivables valued at US$823.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.95b.
This deficit is considerable relative to its market capitalization of US$6.93b, so it does suggest shareholders should keep an eye on Change Healthcare's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Change Healthcare can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Change Healthcare managed to produce its first revenue as a listed company, but given the lack of profit, shareholders will no doubt be hoping to see some strong increases.
Over the last twelve months Change Healthcare produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at US$123m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of US$966m into a profit. So we do think this stock is quite risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Change Healthcare .
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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