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. 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. We can see that Green Cross Health Limited (NZSE:GXH) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Green Cross Health Carry?
As you can see below, Green Cross Health had NZ$49.1m of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. On the flip side, it has NZ$16.7m in cash leading to net debt of about NZ$32.5m.
A Look At Green Cross Health's Liabilities
Zooming in on the latest balance sheet data, we can see that Green Cross Health had liabilities of NZ$107.3m due within 12 months and liabilities of NZ$23.6m due beyond that. Offsetting this, it had NZ$16.7m in cash and NZ$36.1m in receivables that were due within 12 months. So it has liabilities totalling NZ$78.1m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Green Cross Health is worth NZ$141.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Green Cross Health's net debt is only 0.94 times its EBITDA. And its EBIT covers its interest expense a whopping 14.7 times over. So we're pretty relaxed about its super-conservative use of debt. While Green Cross Health doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Green Cross Health will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Green Cross Health recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
On our analysis Green Cross Health's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. Considering this range of data points, we think Green Cross Health is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Green Cross Health's dividend history, without delay!
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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