Here's Why American Shared Hospital Services (NYSEMKT:AMS) Has A Meaningful Debt Burden

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that American Shared Hospital Services (NYSEMKT:AMS) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for American Shared Hospital Services

What Is American Shared Hospital Services's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 American Shared Hospital Services had US$4.94m of debt, an increase on US$3.90m, over one year. However, because it has a cash reserve of US$3.62m, its net debt is less, at about US$1.32m.

How Healthy Is American Shared Hospital Services's Balance Sheet?

We can see from the most recent balance sheet that American Shared Hospital Services had liabilities of US$8.03m falling due within a year, and liabilities of US$13.6m due beyond that. Offsetting these obligations, it had cash of US$3.62m as well as receivables valued at US$5.69m due within 12 months. So its liabilities total US$12.3m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of US$11.6m, we think shareholders really should watch American Shared Hospital Services's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Given net debt is only 0.18 times EBITDA, it is initially surprising to see that American Shared Hospital Services's EBIT has low interest coverage of 0.57 times. So one way or the other, it's clear the debt levels are not trivial. Shareholders should be aware that American Shared Hospital Services's EBIT was down 78% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since American Shared Hospital Services will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, American Shared Hospital Services 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

While American Shared Hospital Services's EBIT growth rate has us nervous. To wit both its conversion of EBIT to free cash flow and net debt to EBITDA were encouraging signs. It's also worth noting that American Shared Hospital Services is in the Healthcare industry, which is often considered to be quite defensive. When we consider all the factors discussed, it seems to us that American Shared Hospital Services 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. 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 American Shared Hospital Services is showing 1 warning sign 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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This article by Simply Wall St is general in nature. 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.
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