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. As with many other companies Cerner Corporation (NASDAQ:CERN) makes use of debt. But should shareholders be worried about its use of debt?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Cerner’s Net Debt?
As you can see below, at the end of September 2021, Cerner had US$1.86b of debt, up from US$1.38b a year ago. Click the image for more detail. However, it does have US$782.2m in cash offsetting this, leading to net debt of about US$1.08b.
How Strong Is Cerner’s Balance Sheet?
The latest balance sheet data shows that Cerner had liabilities of US$1.55b due within a year, and liabilities of US$2.15b falling due after that. Offsetting this, it had US$782.2m in cash and US$1.22b in receivables that were due within 12 months. So it has liabilities totalling US$1.70b more than its cash and near-term receivables, combined.
Since publicly traded Cerner shares are worth a very impressive total of US$21.3b, it seems unlikely that this level of liabilities would be a major threat. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Cerner’s net debt is only 0.74 times its EBITDA. And its EBIT covers its interest expense a whopping 6k times over. So we’re pretty relaxed about its super-conservative use of debt. And we also note warmly that Cerner grew its EBIT by 20% last year, making its debt load easier to handle. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Cerner 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. So it’s worth checking how much of that EBIT is backed by free cash flow. During the last three years, Cerner generated free cash flow amounting to a very robust 90% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
Cerner’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. And that’s just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. It’s also worth noting that Cerner is in the Healthcare Services industry, which is often considered to be quite defensive. Considering this range of factors, it seems to us that Cerner is quite prudent with its debt, and the risks seem well managed. So we’re not worried about the use of a little leverage on the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. Be aware that Cerner is showing 2 warning signs in our investment analysis , you should know about…
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.