Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Select Medical Holdings Corporation (NYSE:SEM) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.
How Much Debt Does Select Medical Holdings Carry?
As you can see below, Select Medical Holdings had US$1.82b of debt at March 2025, down from US$3.85b a year prior. However, it also had US$53.2m in cash, and so its net debt is US$1.76b.
A Look At Select Medical Holdings' Liabilities
According to the last reported balance sheet, Select Medical Holdings had liabilities of US$944.8m due within 12 months, and liabilities of US$2.71b due beyond 12 months. Offsetting these obligations, it had cash of US$53.2m as well as receivables valued at US$908.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.69b.
Given this deficit is actually higher than the company's market capitalization of US$1.96b, we think shareholders really should watch Select Medical Holdings's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
View our latest analysis for Select Medical Holdings
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.
While Select Medical Holdings's debt to EBITDA ratio (4.6) suggests that it uses some debt, its interest cover is very weak, at 2.2, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. On a slightly more positive note, Select Medical Holdings grew its EBIT at 12% over the last year, further increasing its ability to manage debt. 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 Select Medical Holdings'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.
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. During the last three years, Select Medical Holdings produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Select Medical Holdings's level of total liabilities and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. We should also note that Healthcare industry companies like Select Medical Holdings commonly do use debt without problems. Taking the abovementioned factors together we do think Select Medical Holdings's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Select Medical Holdings (1 doesn't sit too well with us) you should be aware of.
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.