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.’ 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 Stride, Inc. (NYSE:LRN) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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.
What Is Stride’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2021 Stride had US$295.4m of debt, an increase on US$100.0m, over one year. But on the other hand it also has US$329.0m in cash, leading to a US$33.6m net cash position.
A Look At Stride’s Liabilities
According to the last reported balance sheet, Stride had liabilities of US$254.8m due within 12 months, and liabilities of US$492.6m due beyond 12 months. Offsetting this, it had US$329.0m in cash and US$422.8m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.
Having regard to Stride’s size, it seems that its liquid assets are well balanced with its total liabilities. So it’s very unlikely that the US$1.27b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Stride has more cash than debt is arguably a good indication that it can manage its debt safely.
Even more impressive was the fact that Stride grew its EBIT by 228% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Stride can strengthen its balance sheet over time.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Stride has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Stride recorded free cash flow worth a fulsome 80% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
Summing up
While it is always sensible to investigate a company’s debt, in this case Stride has US$33.6m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$44m, being 80% of its EBIT. So we don’t think Stride’s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt.