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. We note that Brookdale Senior Living Inc. (NYSE:BKD) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Brookdale Senior Living's Net Debt?

The chart below, which you can click on for greater detail, shows that Brookdale Senior Living had US$3.71b in debt in September 2024; about the same as the year before. On the flip side, it has US$284.4m in cash leading to net debt of about US$3.42b.

A Look At Brookdale Senior Living's Liabilities

According to the last reported balance sheet, Brookdale Senior Living had liabilities of US$584.0m due within 12 months, and liabilities of US$5.06b due beyond 12 months. Offsetting this, it had US$284.4m in cash and US$53.0m in receivables that were due within 12 months. So it has liabilities totalling US$5.31b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$1.08b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Brookdale Senior Living would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Brookdale Senior Living shareholders face the double whammy of a high net debt to EBITDA ratio (8.2), and fairly weak interest coverage, since EBIT is just 0.30 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for Brookdale Senior Living is that it turned last year's EBIT loss into a gain of US$68m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Brookdale Senior Living's ability to maintain a healthy balance sheet going forward. 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 the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Brookdale Senior Living burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Brookdale Senior Living's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. We should also note that Healthcare industry companies like Brookdale Senior Living commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like Brookdale Senior Living has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Brookdale Senior Living that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.