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.’ 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 note that Invacare Corporation (NYSE:IVC) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
What Is Invacare’s Net Debt?
As you can see below, at the end of June 2021, Invacare had US$312.6m of debt, up from US$257.1m a year ago. Click the image for more detail. However, it does have US$78.3m in cash offsetting this, leading to net debt of about US$234.4m.
How Healthy Is Invacare’s Balance Sheet?
We can see from the most recent balance sheet that Invacare had liabilities of US$244.9m falling due within a year, and liabilities of US$448.1m due beyond that. On the other hand, it had cash of US$78.3m and US$148.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$466.7m.
This deficit casts a shadow over the US$205.1m company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt. At the end of the day, Invacare would probably need a major re-capitalization if its creditors were to demand repayment.
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.
Weak interest cover of 0.0032 times and a disturbingly high net debt to EBITDA ratio of 14.6 hit our confidence in Invacare like a one-two punch to the gut. This means we’d consider it to have a heavy debt load. Even worse, Invacare saw its EBIT tank 99% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Invacare’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, 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 last two years, Invacare saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
On the face of it, Invacare’s EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. We should also note that Medical Equipment industry companies like Invacare commonly do use debt without problems. It looks to us like Invacare carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we’d probably stay away from this particular stock. When analysing debt levels, the balance sheet is the obvious place to start.