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.' 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. We note that Centene Corporation (NYSE:CNC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Centene's Debt?
As you can see below, Centene had US$18.0b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$19.7b in cash, leading to a US$1.67b net cash position.
A Look At Centene's Liabilities
The latest balance sheet data shows that Centene had liabilities of US$32.8b due within a year, and liabilities of US$22.8b falling due after that. Offsetting these obligations, it had cash of US$19.7b as well as receivables valued at US$16.8b due within 12 months. So it has liabilities totalling US$19.1b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Centene is worth a massive US$41.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Centene boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that Centene has increased its EBIT by 7.6% over twelve months, which should ease any concerns about debt repayment. 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 Centene can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Centene 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, Centene actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing Up
Although Centene's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$1.67b. And it impressed us with free cash flow of US$2.6b, being 117% of its EBIT. So we don't have any problem with Centene's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Centene insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.