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 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 Computer Programs and Systems, Inc. (NASDAQ:CPSI) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Computer Programs and Systems Carry?
As you can see below, at the end of June 2022, Computer Programs and Systems had US$141.1m of debt, up from US$116.1m a year ago. Click the image for more detail. However, it does have US$15.1m in cash offsetting this, leading to net debt of about US$126.0m.
A Look At Computer Programs and Systems' Liabilities
Zooming in on the latest balance sheet data, we can see that Computer Programs and Systems had liabilities of US$48.7m due within 12 months and liabilities of US$163.8m due beyond that. Offsetting these obligations, it had cash of US$15.1m as well as receivables valued at US$53.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$143.5m.
While this might seem like a lot, it is not so bad since Computer Programs and Systems has a market capitalization of US$418.3m, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With net debt to EBITDA of 2.7 Computer Programs and Systems has a fairly noticeable amount of debt. On the plus side, its EBIT was 7.4 times its interest expense, and its net debt to EBITDA, was quite high, at 2.7. If Computer Programs and Systems can keep growing EBIT at last year's rate of 12% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Computer Programs and Systems 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 we always check how much of that EBIT is translated into free cash flow. Over the last three years, Computer Programs and Systems actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our View
The good news is that Computer Programs and Systems's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. It's also worth noting that Computer Programs and Systems is in the Healthcare Services industry, which is often considered to be quite defensive. When we consider the range of factors above, it looks like Computer Programs and Systems is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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 2 warning signs with Computer Programs and Systems , and understanding them should be part of your investment process.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
