Is U.S. Physical Therapy (NYSE:USPH) Using Too Much Debt?

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.' 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 can see that U.S. Physical Therapy, Inc. (NYSE:USPH) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for U.S. Physical Therapy

How Much Debt Does U.S. Physical Therapy Carry?

The image below, which you can click on for greater detail, shows that U.S. Physical Therapy had debt of US$21.7m at the end of March 2021, a reduction from US$119.3m over a year. However, because it has a cash reserve of US$17.9m, its net debt is less, at about US$3.71m.

How Strong Is U.S. Physical Therapy's Balance Sheet?

We can see from the most recent balance sheet that U.S. Physical Therapy had liabilities of US$90.8m falling due within a year, and liabilities of US$91.4m due beyond that. On the other hand, it had cash of US$17.9m and US$54.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$110.3m.

Of course, U.S. Physical Therapy has a market capitalization of US$1.43b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, U.S. Physical Therapy has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

U.S. Physical Therapy has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.05 and EBIT of 49.0 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. Fortunately, U.S. Physical Therapy grew its EBIT by 6.4% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine U.S. Physical Therapy'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, U.S. Physical Therapy actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

U.S. Physical Therapy's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! It's also worth noting that U.S. Physical Therapy is in the Healthcare industry, which is often considered to be quite defensive. Considering this range of factors, it seems to us that U.S. Physical Therapy is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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 U.S. Physical Therapy is showing 2 warning signs in our investment analysis , you should know about...

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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