U.S. Physical Therapy (NYSE:USPH) Has A Pretty 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.' 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. As with many other companies U.S. Physical Therapy, Inc. (NYSE:USPH) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for U.S. Physical Therapy

What Is U.S. Physical Therapy's Debt?

As you can see below, at the end of December 2022, U.S. Physical Therapy had US$183.7m of debt, up from US$118.4m a year ago. Click the image for more detail. However, because it has a cash reserve of US$34.5m, its net debt is less, at about US$149.2m.

A Look At U.S. Physical Therapy's Liabilities

According to the last reported balance sheet, U.S. Physical Therapy had liabilities of US$85.5m due within 12 months, and liabilities of US$288.1m due beyond 12 months. Offsetting this, it had US$34.5m in cash and US$68.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$270.5m.

This deficit isn't so bad because U.S. Physical Therapy is worth US$1.28b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

U.S. Physical Therapy's net debt to EBITDA ratio of about 1.9 suggests only moderate use of debt. And its commanding EBIT of 13.4 times its interest expense, implies the debt load is as light as a peacock feather. Unfortunately, U.S. Physical Therapy saw its EBIT slide 6.7% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if U.S. Physical Therapy 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, U.S. Physical Therapy actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, U.S. Physical Therapy's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its EBIT growth rate. It's also worth noting that U.S. Physical Therapy is in the Healthcare industry, which is often considered to be quite defensive. Taking all this data into account, it seems to us that U.S. Physical Therapy takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. Case in point: We've spotted 2 warning signs for U.S. Physical Therapy you should be aware of.

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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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.