Here's Why Five Star Senior Living (NASDAQ:FVE) Can Manage Its Debt Responsibly
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Five Star Senior Living Inc. (NASDAQ:FVE) does carry debt. But is this debt a concern to shareholders?
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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Five Star Senior Living
How Much Debt Does Five Star Senior Living Carry?
The image below, which you can click on for greater detail, shows that Five Star Senior Living had debt of US$7.36m at the end of June 2020, a reduction from US$7.71m over a year. However, its balance sheet shows it holds US$85.2m in cash, so it actually has US$77.9m net cash.
How Healthy Is Five Star Senior Living's Balance Sheet?
The latest balance sheet data shows that Five Star Senior Living had liabilities of US$145.5m due within a year, and liabilities of US$67.5m falling due after that. Offsetting these obligations, it had cash of US$85.2m as well as receivables valued at US$82.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$44.9m.
This deficit isn't so bad because Five Star Senior Living is worth US$151.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Five Star Senior Living 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, Five Star Senior Living turned things around in the last 12 months, delivering and EBIT of US$13m. 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 Five Star Senior Living 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, a company can only pay off debt with cold hard cash, not accounting profits. Five Star Senior Living 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. Over the last year, Five Star Senior Living saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing up
While Five Star Senior Living does have more liabilities than liquid assets, it also has net cash of US$77.9m. So we are not troubled with Five Star Senior Living's debt use. 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Five Star Senior Living you should know about.
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. 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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