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. Importantly, Humana Inc. (NYSE:HUM) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Humana’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Humana had US$12.0b of debt, an increase on US$10.8b, over one year. However, it does have US$30.3b in cash offsetting this, leading to net cash of US$18.3b.
How Healthy Is Humana’s Balance Sheet?
We can see from the most recent balance sheet that Humana had liabilities of US$27.8b falling due within a year, and liabilities of US$11.1b due beyond that. Offsetting these obligations, it had cash of US$30.3b as well as receivables valued at US$1.82b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.78b.
Given Humana has a humongous market capitalization of US$61.0b, it’s hard to believe these liabilities pose much threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Humana also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Another good sign is that Humana has been able to increase its EBIT by 20% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Humana’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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Humana has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Humana 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.
Although Humana’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$18.3b. The cherry on top was that in converted 116% of that EBIT to free cash flow, bringing in US$5.0b. So is Humana’s debt a risk? It doesn’t seem so to us. Another factor that would give us confidence in Humana 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.
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.
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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.