Does HealthEquity (NASDAQ:HQY) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that HealthEquity, Inc. (NASDAQ:HQY) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for HealthEquity

What Is HealthEquity's Debt?

As you can see below, HealthEquity had US$925.3m of debt, at January 2023, which is about the same as the year before. You can click the chart for greater detail. However, it also had US$254.3m in cash, and so its net debt is US$671.1m.

How Healthy Is HealthEquity's Balance Sheet?

The latest balance sheet data shows that HealthEquity had liabilities of US$131.1m due within a year, and liabilities of US$1.06b falling due after that. Offsetting this, it had US$254.3m in cash and US$96.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$842.2m.

Since publicly traded HealthEquity shares are worth a total of US$4.98b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While HealthEquity's debt to EBITDA ratio (3.4) suggests that it uses some debt, its interest cover is very weak, at 0.81, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even more troubling is the fact that HealthEquity actually let its EBIT decrease by 7.2% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine HealthEquity's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, HealthEquity recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

HealthEquity's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its conversion of EBIT to free cash flow. We would also note that Healthcare industry companies like HealthEquity commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about HealthEquity's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. We'd be motivated to research the stock further if we found out that HealthEquity insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.