These 4 Measures Indicate That Tivity Health (NASDAQ:TVTY) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Tivity Health, Inc. (NASDAQ:TVTY) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Tivity Health

What Is Tivity Health's Debt?

As you can see below, Tivity Health had US$505.4m of debt at March 2021, down from US$1.13b a year prior. However, it does have US$52.4m in cash offsetting this, leading to net debt of about US$452.9m.

How Healthy Is Tivity Health's Balance Sheet?

The latest balance sheet data shows that Tivity Health had liabilities of US$89.1m due within a year, and liabilities of US$424.5m falling due after that. Offsetting these obligations, it had cash of US$52.4m as well as receivables valued at US$45.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$415.5m.

Tivity Health has a market capitalization of US$1.19b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Tivity Health has a debt to EBITDA ratio of 3.2 and its EBIT covered its interest expense 3.2 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Tivity Health's EBIT was pretty flat over the last year, which isn't ideal given the debt load. 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 Tivity Health 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, Tivity Health recorded free cash flow worth a fulsome 81% 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

When it comes to the balance sheet, the standout positive for Tivity Health was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. We would also note that Healthcare industry companies like Tivity Health commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Tivity Health is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Tivity Health that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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