Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, ProPhase Labs, Inc. (NASDAQ:PRPH) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is ProPhase Labs's Debt?
As you can see below, ProPhase Labs had US$8.00m of debt at June 2022, down from US$9.99m a year prior. However, its balance sheet shows it holds US$27.5m in cash, so it actually has US$19.5m net cash.
How Strong Is ProPhase Labs' Balance Sheet?
According to the last reported balance sheet, ProPhase Labs had liabilities of US$16.7m due within 12 months, and liabilities of US$13.1m due beyond 12 months. Offsetting this, it had US$27.5m in cash and US$36.7m in receivables that were due within 12 months. So it actually has US$34.4m more liquid assets than total liabilities.
This excess liquidity suggests that ProPhase Labs is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, ProPhase Labs boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, ProPhase Labs turned things around in the last 12 months, delivering and EBIT of US$37m. 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 ProPhase Labs 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ProPhase Labs may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last year, ProPhase Labs's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that ProPhase Labs has net cash of US$19.5m, as well as more liquid assets than liabilities. So we are not troubled with ProPhase Labs's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 5 warning signs we've spotted with ProPhase Labs (including 2 which are significant) .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.
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