We Think Prestige Consumer Healthcare (NYSE:PBH) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Prestige Consumer Healthcare Inc. (NYSE:PBH) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Prestige Consumer Healthcare

What Is Prestige Consumer Healthcare's Debt?

As you can see below, Prestige Consumer Healthcare had US$1.09b of debt at June 2024, down from US$1.32b a year prior. However, it does have US$34.3m in cash offsetting this, leading to net debt of about US$1.06b.

How Healthy Is Prestige Consumer Healthcare's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Prestige Consumer Healthcare had liabilities of US$114.1m due within 12 months and liabilities of US$1.51b due beyond that. Offsetting these obligations, it had cash of US$34.3m as well as receivables valued at US$171.7m due within 12 months. So its liabilities total US$1.42b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Prestige Consumer Healthcare is worth US$3.67b, 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Prestige Consumer Healthcare has a debt to EBITDA ratio of 2.9 and its EBIT covered its interest expense 5.3 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Sadly, Prestige Consumer Healthcare's EBIT actually dropped 4.8% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Prestige Consumer Healthcare 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by 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

On our analysis Prestige Consumer Healthcare's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. 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 we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 1 warning sign with Prestige Consumer Healthcare , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.