David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Da Vita Inc. (NYSE:DVA) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for DaVita
What is DaVita’s debt?
You can click on the graph below for historical numbers, but it shows that in December 2021, DaVita had debt of US$8.61 billion, an increase from US$7.81 billion, on a year. On the other hand, it has $484.2 million in cash, resulting in a net debt of around $8.12 billion.
How strong is DaVita’s balance sheet?
The latest balance sheet data shows that DaVita had liabilities of US$2.40 billion due within one year, and liabilities of US$12.4 billion falling due thereafter. On the other hand, it had liquidities of 484.2 million dollars and 2.41 billion dollars of receivables at less than one year. Thus, its liabilities total $11.9 billion more than the combination of its cash and short-term receivables.
When you consider that this shortfall exceeds the company’s huge US$10.3 billion market capitalization, you might well be inclined to take a close look at the balance sheet. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
DaVita has a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 6.3 times. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. DaVita increased its EBIT by 3.0% over the past year. It’s far from amazing, but it’s a good thing when it comes to paying down debt. When analyzing debt levels, the balance sheet is the obvious starting point. But future earnings, more than anything, will determine DaVita’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, DaVita has recorded free cash flow worth 83% of its EBIT, which is higher than we would normally expect. This positions him well to pay off debt if desired.
Our point of view
DaVita’s level of total liabilities and net debt to EBITDA is certainly weighing on it, in our view. But its conversion of EBIT to free cash flow tells a very different story and suggests some resilience. It’s also worth noting that healthcare companies like DaVita generally use debt without issue. Looking at all the angles discussed above, it does seem to us that DaVita is a somewhat risky investment due to its leverage. Not all risk is bad, as it can increase stock price returns if it pays off, but this leverage risk is worth keeping in mind. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 2 warning signs for DaVita you should be aware.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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