Charlie Munger-backed outside fund manager of Berkshire Hathaway, Lee Lu, is nonchalant when he says “The biggest investment risk is not price volatility, but whether you will suffer a permanent loss of principal.” So it seems the smart money knows that debt – which is usually implicated in bankruptcies – is a very important factor, when assessing how risky a company is. As with many other companies American Public Education, Inc. (NASDAQ:APEI) is benefiting from debt. But the real question is whether that debt makes the company risky.
When is debt a problem?
Debt helps the company until it has trouble paying it back, either with new capital or with free cash flow. Embedded in capitalism is the process of “creative destruction” whereby failing companies are ruthlessly liquidated by bankers. Although this is not very common, we often see highly indebted companies permanently disempowering shareholders because lenders force them to raise capital at a distressed rate. Having said that, the most common situation is when a company manages its debt sensibly – and in its own interest. When we examine debt levels, we first consider both cash and debt levels.
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What is the American debt to public education?
You can click on the graph below for historical numbers, but it shows that American public education had a debt of $93.2 million in December 2022, down from $160.5 million, one year earlier. But she also has $102.6 million in cash to make up for that, which means she has $9.41 million in net cash.
How strong is the American public education balance sheet?
According to the last reported balance sheet, American public education had liabilities of $70.8 million due within 12 months, and liabilities of $194.6 million due after 12 months. Against this, she had $102.6 million in cash and $45.2 million in receivables that were due within 12 months. Therefore, its liabilities exceed the sum of cash and receipts (short-term) by US$ 117.5 million.
This shortfall is large relative to its market value of $121.8 million, so it suggests that shareholders should keep an eye on the US public education’s use of debt. If its lenders demand balance sheet support, shareholders will likely face severe dilution. While she has noteworthy liabilities, American Public Education also has more cash than debt, so we’re pretty confident she can safely manage her debt.
Most importantly, the return before interest and taxes (EBIT) for American public education has fallen by 68% in the past 12 months. If this earnings trend continues, paying off its debt will be as easy as herding cats onto a roller coaster. Obviously, the balance sheet is the area to focus on when analyzing debt. But future earnings, more than anything else, will determine American public education’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future, you can check this out free A report showing analysts’ earnings expectations.
Finally, while a tax man may adore accounting profits, lenders will only accept cold hard cash. American Public Education may have net cash on the balance sheet, but it’s still interesting to consider how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, because that will affect both its need for, and ability to manage Debts. Over the last three years, American Public Education has recorded free cash flow of 70% of its earnings before interest and taxes, which is almost normal, since free cash flow excludes interest and taxes. This cold steady cash means he can reduce his debt when he wants to.
Summary of the above
While American Public Education has more liabilities than liquid assets, it has net cash of $9.41 million. The cherry on top was that 70% of that EBIT was converted into free cash flow, bringing in $13 million. Despite the cash, we find American Public Education’s EBIT growth rate to be concerning, so we don’t feel particularly comfortable with the stock. There is no doubt that we learn more about debt than the balance sheet. But in the end, every company can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every company has them, and we’ve spotted them 1 warning sign for American public education You should know about it.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, feel free to discover our exclusive list of net cash growth today.
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