Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, AdaptHealth Corp. (NASDAQ:AHCO) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is AdaptHealth's Net Debt?

You can click the graphic below for the historical numbers, but it shows that AdaptHealth had US$2.08b of debt in June 2024, down from US$2.18b, one year before. However, it does have US$74.7m in cash offsetting this, leading to net debt of about US$2.01b.

How Strong Is AdaptHealth's Balance Sheet?

The latest balance sheet data shows that AdaptHealth had liabilities of US$596.0m due within a year, and liabilities of US$2.42b falling due after that. Offsetting these obligations, it had cash of US$74.7m as well as receivables valued at US$437.1m due within 12 months. So it has liabilities totalling US$2.51b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$1.46b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, AdaptHealth would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While AdaptHealth's debt to EBITDA ratio (3.0) suggests that it uses some debt, its interest cover is very weak, at 2.2, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. The good news is that AdaptHealth grew its EBIT a smooth 45% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine AdaptHealth's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, AdaptHealth's free cash flow amounted to 27% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, AdaptHealth's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. It's also worth noting that AdaptHealth is in the Healthcare industry, which is often considered to be quite defensive. Overall, we think it's fair to say that AdaptHealth has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. Given our hesitation about the stock, it would be good to know if AdaptHealth insiders have sold any shares recently. You click here to find out if insiders have sold recently.

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.