Is Premier (NASDAQ:PINC) Using Too Much Debt?

By
Simply Wall St
Published
November 16, 2021
NasdaqGS:PINC
Source: Shutterstock

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.' 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 Premier, Inc. (NASDAQ:PINC) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Premier

What Is Premier's Net Debt?

The image below, which you can click on for greater detail, shows that Premier had debt of US$551.9m at the end of September 2021, a reduction from US$598.0m over a year. On the flip side, it has US$184.4m in cash leading to net debt of about US$367.5m.

debt-equity-history-analysis
NasdaqGS:PINC Debt to Equity History November 17th 2021

How Healthy Is Premier's Balance Sheet?

We can see from the most recent balance sheet that Premier had liabilities of US$757.0m falling due within a year, and liabilities of US$481.8m due beyond that. Offsetting these obligations, it had cash of US$184.4m as well as receivables valued at US$411.2m due within 12 months. So it has liabilities totalling US$643.3m more than its cash and near-term receivables, combined.

Since publicly traded Premier shares are worth a total of US$4.90b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Premier has a low net debt to EBITDA ratio of only 0.89. And its EBIT covers its interest expense a whopping 435 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that Premier has seen its EBIT plunge 20% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Premier can strengthen its balance sheet over time. 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. Over the last three years, Premier recorded free cash flow worth a fulsome 95% 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 Premier's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its EBIT growth rate. We would also note that Healthcare industry companies like Premier commonly do use debt without problems. All these things considered, it appears that Premier can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. Be aware that Premier is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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