Pennant Group (NASDAQ:PNTG) Takes On Some Risk With Its Use Of Debt

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. We can see that The Pennant Group, Inc. (NASDAQ:PNTG) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Pennant Group

How Much Debt Does Pennant Group Carry?

As you can see below, Pennant Group had US$53.8m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$3.38m in cash offsetting this, leading to net debt of about US$50.4m.

How Healthy Is Pennant Group's Balance Sheet?

The latest balance sheet data shows that Pennant Group had liabilities of US$68.8m due within a year, and liabilities of US$312.0m falling due after that. Offsetting this, it had US$3.38m in cash and US$59.4m in receivables that were due within 12 months. So its liabilities total US$318.1m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$423.8m. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Pennant Group's net debt is sitting at a very reasonable 1.6 times its EBITDA, while its EBIT covered its interest expense just 4.7 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Pennant Group grew its EBIT by 88% over the last twelve months, and that growth will make it easier to handle its 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 Pennant Group 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.

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. Considering the last three years, Pennant Group actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Pennant Group's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. It's also worth noting that Pennant Group is in the Healthcare industry, which is often considered to be quite defensive. Looking at all the angles mentioned above, it does seem to us that Pennant Group is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Given our hesitation about the stock, it would be good to know if Pennant Group insiders have sold any shares recently. You click here to find out if insiders have sold recently.

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.