Does Evolent Health (NYSE:EVH) Have A Healthy Balance Sheet?

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.' 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 can see that Evolent Health, Inc. (NYSE:EVH) does use debt in its business. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Evolent Health

What Is Evolent Health's Debt?

As you can see below, at the end of June 2023, Evolent Health had US$633.0m of debt, up from US$283.1m a year ago. Click the image for more detail. However, it does have US$142.5m in cash offsetting this, leading to net debt of about US$490.5m.

How Healthy Is Evolent Health's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Evolent Health had liabilities of US$540.9m due within 12 months and liabilities of US$839.9m due beyond that. On the other hand, it had cash of US$142.5m and US$345.3m worth of receivables due within a year. So its liabilities total US$893.0m more than the combination of its cash and short-term receivables.

Evolent Health has a market capitalization of US$3.05b, 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.

Weak interest cover of 0.52 times and a disturbingly high net debt to EBITDA ratio of 5.6 hit our confidence in Evolent Health like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, it should be some comfort for shareholders to recall that Evolent Health actually grew its EBIT by a hefty 841%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. 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 Evolent 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last two years, Evolent Health burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Evolent Health's ability to convert EBIT to free cash flow nor its interest cover gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. It's also worth noting that Evolent Health is in the Healthcare Services industry, which is often considered to be quite defensive. When we consider all the factors discussed, it seems to us that Evolent Health is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Be aware that Evolent Health is showing 2 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.