These 4 Measures Indicate That K12 (NYSE:LRN) Is Using Debt Reasonably Well
David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 K12 Inc. (NYSE:LRN) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for K12
How Much Debt Does K12 Carry?
The image below, which you can click on for greater detail, shows that at June 2020 K12 had debt of US$100.0m, up from none in one year. But on the other hand it also has US$212.3m in cash, leading to a US$112.3m net cash position.
A Look At K12's Liabilities
According to the last reported balance sheet, K12 had liabilities of US$273.4m due within 12 months, and liabilities of US$124.5m due beyond 12 months. Offsetting these obligations, it had cash of US$212.3m as well as receivables valued at US$236.1m due within 12 months. So it actually has US$50.5m more liquid assets than total liabilities.
This short term liquidity is a sign that K12 could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that K12 has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact K12's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if K12 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. K12 may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, K12 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.
Summing up
While it is always sensible to investigate a company's debt, in this case K12 has US$112.3m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 182% of that EBIT to free cash flow, bringing in US$35m. So we are not troubled with K12's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with K12 , and understanding them should be part of your investment process.
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. 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.
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