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.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Acadia Healthcare Company, Inc. (NASDAQ:ACHC) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Acadia Healthcare Company
What Is Acadia Healthcare Company’s Debt?
The image below, which you can click on for greater detail, shows that Acadia Healthcare Company had debt of US$1.42b at the end of March 2023, a reduction from US$1.49b over a year. On the flip side, it has US$63.8m in cash leading to net debt of about US$1.36b.
How Healthy Is Acadia Healthcare Company’s Balance Sheet?
The latest balance sheet data shows that Acadia Healthcare Company had liabilities of US$378.1m due within a year, and liabilities of US$1.74b falling due after that. On the other hand, it had cash of US$63.8m and US$420.4m worth of receivables due within a year. So it has liabilities totalling US$1.63b more than its cash and near-term receivables, combined.
This deficit isn’t so bad because Acadia Healthcare Company is worth US$6.38b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Acadia Healthcare Company has net debt worth 2.3 times EBITDA, which isn’t too much, but its interest cover looks a bit on the low side, with EBIT at only 6.2 times the interest expense. While these numbers do not alarm us, it’s worth noting that the cost of the company’s debt is having a real impact. If Acadia Healthcare Company can keep growing EBIT at last year’s rate of 13% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Acadia Healthcare Company can strengthen its balance sheet over time. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Acadia Healthcare Company produced sturdy free cash flow equating to 52% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
We feel that Acadia Healthcare Company’s solid EBIT growth rate was really heart warming, like a mid-winter fair trade hot chocolate in a tasteful alpine chalet. And its conversion of EBIT to free cash flow should also leave shareholders feeling frolicsome. We would also note that Healthcare industry companies like Acadia Healthcare Company commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that Acadia Healthcare Company can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it’s worth monitoring the balance sheet. 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 1 warning sign for Acadia Healthcare Company you should be aware of.
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.
What are the risks and opportunities for Acadia Healthcare Company?
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