The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Heska Corporation (NASDAQ:HSKA) makes use of debt. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Heska's Net Debt?
As you can see below, at the end of June 2021, Heska had US$83.9m of debt, up from US$50.0m a year ago. Click the image for more detail. But it also has US$245.2m in cash to offset that, meaning it has US$161.2m net cash.
How Strong Is Heska's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Heska had liabilities of US$41.5m due within 12 months and liabilities of US$104.1m due beyond that. On the other hand, it had cash of US$245.2m and US$34.7m worth of receivables due within a year. So it can boast US$134.2m more liquid assets than total liabilities.
This short term liquidity is a sign that Heska could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Heska has more cash than debt is arguably a good indication that it can manage its debt safely.
We also note that Heska improved its EBIT from a last year's loss to a positive US$5.1m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Heska'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, a company can only pay off debt with cold hard cash, not accounting profits. Heska 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. Happily for any shareholders, Heska actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Heska has net cash of US$161.2m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$19m, being 365% of its EBIT. So we don't think Heska's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Heska that you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
