Here's Why Prestige Consumer Healthcare (NYSE:PBH) Can Manage Its Debt Responsibly

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Prestige Consumer Healthcare Inc. (NYSE:PBH) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Prestige Consumer Healthcare

What Is Prestige Consumer Healthcare's Net Debt?

The image below, which you can click on for greater detail, shows that Prestige Consumer Healthcare had debt of US$992.0m at the end of December 2024, a reduction from US$1.20b over a year. On the flip side, it has US$50.9m in cash leading to net debt of about US$941.1m.

A Look At Prestige Consumer Healthcare's Liabilities

The latest balance sheet data shows that Prestige Consumer Healthcare had liabilities of US$102.5m due within a year, and liabilities of US$1.44b falling due after that. Offsetting this, it had US$50.9m in cash and US$167.3m in receivables that were due within 12 months. So its liabilities total US$1.32b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Prestige Consumer Healthcare has a market capitalization of US$3.76b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Prestige Consumer Healthcare's debt is 2.6 times its EBITDA, and its EBIT cover its interest expense 6.3 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Sadly, Prestige Consumer Healthcare's EBIT actually dropped 5.4% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 Prestige Consumer Healthcare's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Prestige Consumer Healthcare recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

When it comes to the balance sheet, the standout positive for Prestige Consumer Healthcare was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. For example, its EBIT growth rate makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about Prestige Consumer Healthcare's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Prestige Consumer Healthcare 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.