Invacare (NYSE:IVC) Use Of Debt Could Be Considered Risky

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Invacare Corporation (NYSE:IVC) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Invacare

What Is Invacare's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Invacare had US$309.5m of debt, an increase on US$242.3m, over one year. However, it does have US$73.7m in cash offsetting this, leading to net debt of about US$235.8m.

A Look At Invacare's Liabilities

According to the last reported balance sheet, Invacare had liabilities of US$230.4m due within 12 months, and liabilities of US$451.9m due beyond 12 months. Offsetting these obligations, it had cash of US$73.7m as well as receivables valued at US$141.4m due within 12 months. So its liabilities total US$467.3m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$85.4m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Invacare would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Invacare shareholders face the double whammy of a high net debt to EBITDA ratio (13.9), and fairly weak interest coverage, since EBIT is just 0.018 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Invacare saw its EBIT tank 96% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Invacare's ability to maintain a healthy balance sheet going forward. 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 we always check how much of that EBIT is translated into free cash flow. During the last two years, Invacare 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

On the face of it, Invacare's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its interest cover fails to inspire much confidence. It's also worth noting that Invacare is in the Medical Equipment industry, which is often considered to be quite defensive. Considering everything we've mentioned above, it's fair to say that Invacare is carrying heavy debt load. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. 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. Be aware that Invacare is showing 3 warning signs in our investment analysis , you should know about...

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.

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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.