Here's Why Option Care Health (NASDAQ:OPCH) Can Manage Its Debt Responsibly

By
Simply Wall St
Published
November 22, 2021
NasdaqGS:OPCH
Source: Shutterstock

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Option Care Health, Inc. (NASDAQ:OPCH) does have debt on its balance sheet. 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. 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.

View our latest analysis for Option Care Health

What Is Option Care Health's Net Debt?

The image below, which you can click on for greater detail, shows that Option Care Health had debt of US$1.13b at the end of September 2021, a reduction from US$1.19b over a year. However, because it has a cash reserve of US$200.9m, its net debt is less, at about US$928.7m.

debt-equity-history-analysis
NasdaqGS:OPCH Debt to Equity History November 23rd 2021

How Healthy Is Option Care Health's Balance Sheet?

We can see from the most recent balance sheet that Option Care Health had liabilities of US$485.7m falling due within a year, and liabilities of US$1.20b due beyond that. Offsetting these obligations, it had cash of US$200.9m as well as receivables valued at US$392.6m due within 12 months. So it has liabilities totalling US$1.10b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Option Care Health has a market capitalization of US$5.10b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Option Care Health's net debt to EBITDA ratio of 3.8, we think its super-low interest cover of 2.3 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that Option Care Health grew its EBIT a smooth 68% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Option Care Health 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Option Care Health recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Option Care Health's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its interest cover. It's also worth noting that Option Care Health is in the Healthcare industry, which is often considered to be quite defensive. When we consider the range of factors above, it looks like Option Care Health is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. For example, we've discovered 1 warning sign for Option Care Health that you should be aware of before investing here.

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.

Discounted cash flow calculation for every stock

Simply Wall St does a detailed discounted cash flow calculation every 6 hours for every stock on the market, so if you want to find the intrinsic value of any company just search here. It’s FREE.

Make Confident Investment Decisions

Simply Wall St's Editorial Team provides unbiased, factual reporting on global stocks using in-depth fundamental analysis.
Find out more about our editorial guidelines and team.