Does ModivCare (NASDAQ:MODV) Have A Healthy Balance Sheet?

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.' 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. Importantly, ModivCare Inc. (NASDAQ:MODV) does carry debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for ModivCare

What Is ModivCare's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 ModivCare had US$977.3m of debt, an increase on US$487.4m, over one year. However, it also had US$88.0m in cash, and so its net debt is US$889.3m.

How Healthy Is ModivCare's Balance Sheet?

According to the last reported balance sheet, ModivCare had liabilities of US$553.4m due within 12 months, and liabilities of US$1.12b due beyond 12 months. On the other hand, it had cash of US$88.0m and US$279.1m worth of receivables due within a year. So its liabilities total US$1.31b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$1.34b, so it does suggest shareholders should keep an eye on ModivCare's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

ModivCare shareholders face the double whammy of a high net debt to EBITDA ratio (5.2), and fairly weak interest coverage, since EBIT is just 1.4 times the interest expense. The debt burden here is substantial. Even worse, ModivCare saw its EBIT tank 24% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine ModivCare'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, ModivCare actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On the face of it, ModivCare's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We should also note that Healthcare industry companies like ModivCare commonly do use debt without problems. Overall, we think it's fair to say that ModivCare has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with ModivCare , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.