Accuray (NASDAQ:ARAY) Has A Somewhat Strained Balance Sheet

Simply Wall St

Sat, Oct 19, 2019, 6:42 AM

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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 Accuray Incorporated (NASDAQ:ARAY) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Accuray

What Is Accuray's Net Debt?

As you can see below, at the end of June 2019, Accuray had US$159.8m of debt, up from US$131.1m a year ago. Click the image for more detail. On the flip side, it has US$76.8m in cash leading to net debt of about US$83.0m.

NasdaqGS:ARAY Historical Debt, October 19th 2019

A Look At Accuray's Liabilities

Zooming in on the latest balance sheet data, we can see that Accuray had liabilities of US$192.2m due within 12 months and liabilities of US$196.1m due beyond that. Offsetting these obligations, it had cash of US$76.8m as well as receivables valued at US$112.2m due within 12 months. So it has liabilities totalling US$199.3m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$236.2m, so it does suggest shareholders should keep an eye on Accuray's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Accuray shareholders face the double whammy of a high net debt to EBITDA ratio (8.0), and fairly weak interest coverage, since EBIT is just 0.14 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for Accuray is that it turned last year's EBIT loss into a gain of US$2.1m, over the last twelve months. 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 Accuray can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Accuray burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Accuray's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. We should also note that Medical Equipment industry companies like Accuray commonly do use debt without problems. Overall, it seems to us that Accuray's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. Given the risks around Accuray's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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