Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies IHH Healthcare Berhad (KLSE:IHH) uses debt. But the more important question is: what risk does this debt create?
Why is debt risky?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for IHH Healthcare Berhad
How much debt does IHH Healthcare Berhad have?
You can click on the graph below for historical figures, but it shows that IHH Healthcare Berhad had RM8.74 billion in debt in September 2021, up from RM9.76 billion a year earlier. However, he has RM4.47 billion in cash to offset this, resulting in a net debt of around RM4.27 billion.
How healthy is IHH Healthcare Berhad’s balance sheet?
According to the latest published balance sheet, IHH Healthcare Berhad had liabilities of RM5.99b due within 12 months and liabilities of RM11.6b due beyond 12 months. In return, he had RM4.47 billion in cash and RM2.56 billion in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of RM10.5 billion.
Of course, IHH Healthcare Berhad has a titanic market capitalization of RM55.4b, so these liabilities are probably manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Looking at its net debt to EBITDA ratio of 1.1 and its interest coverage of 6.8 times, it seems to us that IHH Healthcare Berhad is probably using debt quite sensibly. But the interest payments are certainly enough to make us think about the affordability of its debt. Even better, IHH Healthcare Berhad increased its EBIT by 104% last year, which is an impressive improvement. If sustained, this growth will make debt even more manageable in years to come. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether IHH Healthcare Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, IHH Healthcare Berhad has recorded free cash flow of 82% of its EBIT, which is higher than what we would normally expect. This positions him well to pay off debt if desired.
Our point of view
The conversion of EBIT to free cash flow by IHH Healthcare Berhad suggests it can manage its debt as easily as Cristiano Ronaldo could score a goal against an under-14 goalkeeper. And this is only the beginning of good news since its EBIT growth rate is also very encouraging. It should also be noted that IHH Healthcare Berhad belongs to the healthcare sector, which is often seen as quite defensive. Given this range of factors, it seems to us that IHH Healthcare Berhad is quite conservative with its debt, and the risks appear to be well contained. So we are not worried about using a little leverage on the balance sheet. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 1 warning sign for IHH Healthcare Berhad you should be aware.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.