Is ModivCare (NASDAQ:MODV) A Risky Investment?

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

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 ModivCare

What Is ModivCare's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 ModivCare had US$1.07b of debt, an increase on US$978.3m, over one year. And it doesn't have much cash, so its net debt is about the same.

How Strong Is ModivCare's Balance Sheet?

The latest balance sheet data shows that ModivCare had liabilities of US$516.9m due within a year, and liabilities of US$1.09b falling due after that. Offsetting this, it had US$8.07m in cash and US$340.8m in receivables that were due within 12 months. So its liabilities total US$1.26b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$666.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, ModivCare would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.68 times and a disturbingly high net debt to EBITDA ratio of 7.1 hit our confidence in ModivCare like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, ModivCare saw its EBIT tank 30% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if ModivCare 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, ModivCare recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both ModivCare's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. It's also worth noting that ModivCare is in the Healthcare industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think ModivCare has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for ModivCare 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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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.