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, Option Care Health, Inc. (NASDAQ:OPCH) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

How Much Debt Does Option Care Health Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Option Care Health had debt of US$1.11b, up from US$1.06b in one year. On the flip side, it has US$490.2m in cash leading to net debt of about US$621.4m.

How Strong Is Option Care Health's Balance Sheet?

The latest balance sheet data shows that Option Care Health had liabilities of US$763.2m due within a year, and liabilities of US$1.24b falling due after that. Offsetting this, it had US$490.2m in cash and US$474.9m in receivables that were due within 12 months. So it has liabilities totalling US$1.04b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Option Care Health has a market capitalization of US$4.04b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Option Care Health's net debt is sitting at a very reasonable 1.6 times its EBITDA, while its EBIT covered its interest expense just 6.2 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. The good news is that Option Care Health has increased its EBIT by 7.1% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Option Care Health's ability to maintain a healthy balance sheet going forward.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Option Care Health actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Option Care Health's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And we also thought its EBIT growth rate was a positive. It's also worth noting that Option Care Health is in the Healthcare industry, which is often considered to be quite defensive. Taking all this data into account, it seems to us that Option Care Health takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. Be aware that Option Care Health is showing 1 warning sign 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.