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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that HMS Holdings Corp. (NASDAQ:HMSY) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own 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 HMS Holdings’s Debt?
The chart below, which you can click on for greater detail, shows that HMS Holdings had US$240.3m in debt in March 2019; about the same as the year before. However, it also had US$219.9m in cash, and so its net debt is US$20.5m.
How Healthy Is HMS Holdings’s Balance Sheet?
According to the last reported balance sheet, HMS Holdings had liabilities of US$87.1m due within 12 months, and liabilities of US$285.1m due beyond 12 months. On the other hand, it had cash of US$219.9m and US$222.4m worth of receivables due within a year. So it can boast US$70.0m more liquid assets than total liabilities.
This surplus suggests that HMS Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. But either way, HMS Holdings has virtually no net debt, so it’s fair to say it does not have a heavy debt load!
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
HMS Holdings has net debt of just 0.15 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.65 times, which is more than adequate. On top of that, HMS Holdings grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine HMS Holdings’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, HMS Holdings actually produced more free cash flow than EBIT over the last three years. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
The good news is that HMS Holdings’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that’s just the beginning of the good news since its EBIT growth rate is also very heartening. We would also note that Healthcare Services industry companies like HMS Holdings commonly do use debt without problems. We think HMS Holdings is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming. We’d be very excited to see if HMS Holdings insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.