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These 4 Measures Indicate That Tenet Healthcare (NYSE:THC) Is Using Debt Extensively

Simply Wall St

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Tenet Healthcare Corporation (NYSE:THC) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tenet Healthcare

What Is Tenet Healthcare's Debt?

The chart below, which you can click on for greater detail, shows that Tenet Healthcare had US$14.6b in debt in June 2019; about the same as the year before. Net debt is about the same, since the it doesn't have much cash.

NYSE:THC Historical Debt, October 25th 2019

A Look At Tenet Healthcare's Liabilities

We can see from the most recent balance sheet that Tenet Healthcare had liabilities of US$4.15b falling due within a year, and liabilities of US$16.9b due beyond that. Offsetting this, it had US$249.0m in cash and US$3.32b in receivables that were due within 12 months. So its liabilities total US$17.5b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$2.58b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet." So we'd watch its balance sheet closely, without a doubt After all, Tenet Healthcare would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.9 times and a disturbingly high net debt to EBITDA ratio of 5.2 hit our confidence in Tenet Healthcare like a one-two punch to the gut. The debt burden here is substantial. Notably, Tenet Healthcare's EBIT was pretty flat over the last year, which isn't ideal given the debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tenet Healthcare 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Tenet Healthcare created free cash flow amounting to 7.8% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Tenet Healthcare's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. It's also worth noting that Tenet Healthcare is in the Healthcare industry, which is often considered to be quite defensive. Taking into account all the aforementioned factors, it looks like Tenet Healthcare has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Given our concerns about Tenet Healthcare's debt levels, it seems only prudent to check if insiders have been ditching the stock.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.