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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, GoodRx Holdings, Inc. (NASDAQ:GDRX) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is GoodRx Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that GoodRx Holdings had US$491.3m of debt in September 2024, down from US$655.8m, one year before. However, it does have US$423.8m in cash offsetting this, leading to net debt of about US$67.6m.

How Strong Is GoodRx Holdings' Balance Sheet?

According to the last reported balance sheet, GoodRx Holdings had liabilities of US$114.4m due within 12 months, and liabilities of US$544.1m due beyond 12 months. Offsetting this, it had US$423.8m in cash and US$180.4m in receivables that were due within 12 months. So its liabilities total US$54.2m more than the combination of its cash and short-term receivables.

Of course, GoodRx Holdings has a market capitalization of US$1.90b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While GoodRx Holdings's low debt to EBITDA ratio of 0.62 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.6 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Pleasingly, GoodRx Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 245% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if GoodRx Holdings 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, GoodRx Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that GoodRx Holdings's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But truth be told we feel its interest cover does undermine this impression a bit. We would also note that Healthcare Services industry companies like GoodRx Holdings commonly do use debt without problems. Considering this range of factors, it seems to us that GoodRx Holdings is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. Another factor that would give us confidence in GoodRx Holdings would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.