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 BrightSpring Health Services, Inc. (NASDAQ:BTSG) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is BrightSpring Health Services's Debt?

You can click the graphic below for the historical numbers, but it shows that BrightSpring Health Services had US$2.61b of debt in June 2024, down from US$3.46b, one year before. And it doesn't have much cash, so its net debt is about the same.

How Strong Is BrightSpring Health Services' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that BrightSpring Health Services had liabilities of US$1.15b due within 12 months and liabilities of US$2.85b due beyond that. Offsetting these obligations, it had cash of US$25.0m as well as receivables valued at US$1.10b due within 12 months. So its liabilities total US$2.88b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of US$2.57b, we think shareholders really should watch BrightSpring Health Services's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.30 times and a disturbingly high net debt to EBITDA ratio of 9.1 hit our confidence in BrightSpring Health Services like a one-two punch to the gut. The debt burden here is substantial. Worse, BrightSpring Health Services's EBIT was down 64% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 BrightSpring Health Services'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, BrightSpring Health Services recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

To be frank both BrightSpring Health Services's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its conversion of EBIT to free cash flow also fails to instill confidence. We should also note that Healthcare industry companies like BrightSpring Health Services commonly do use debt without problems. After considering the datapoints discussed, we think BrightSpring Health Services has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Given the risks around BrightSpring Health Services's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.

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.

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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.