We Think ProPhase Labs (NASDAQ:PRPH) Can Stay On Top Of Its 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.' 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 ProPhase Labs, Inc. (NASDAQ:PRPH) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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.

View our latest analysis for ProPhase Labs

What Is ProPhase Labs's Net Debt?

The image below, which you can click on for greater detail, shows that ProPhase Labs had debt of US$8.02m at the end of March 2022, a reduction from US$9.99m over a year. However, it does have US$29.4m in cash offsetting this, leading to net cash of US$21.3m.

A Look At ProPhase Labs' Liabilities

Zooming in on the latest balance sheet data, we can see that ProPhase Labs had liabilities of US$19.8m due within 12 months and liabilities of US$13.5m due beyond that. Offsetting these obligations, it had cash of US$29.4m as well as receivables valued at US$36.7m due within 12 months. So it actually has US$32.8m more liquid assets than total liabilities.

It's good to see that ProPhase Labs has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, ProPhase Labs boasts net cash, so it's fair to say it does not have a heavy debt load!

Although ProPhase Labs made a loss at the EBIT level, last year, it was also good to see that it generated US$25m in EBIT over the last twelve months. 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 ProPhase Labs'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. ProPhase Labs may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last year, ProPhase Labs produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case ProPhase Labs has US$21.3m in net cash and a decent-looking balance sheet. So we don't think ProPhase Labs's use of debt is risky. 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. We've identified 4 warning signs with ProPhase Labs (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.