David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Raffles Medical Group Ltd (SGX:BSL) does use debt in its business. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
What Is Raffles Medical Group's Debt?
As you can see below, at the end of June 2019, Raffles Medical Group had S$125.0m of debt, up from S$91.6m a year ago. Click the image for more detail. On the flip side, it has S$101.9m in cash leading to net debt of about S$23.1m.
How Healthy Is Raffles Medical Group's Balance Sheet?
According to the last reported balance sheet, Raffles Medical Group had liabilities of S$200.1m due within 12 months, and liabilities of S$151.4m due beyond 12 months. Offsetting this, it had S$101.9m in cash and S$92.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$156.9m.
Of course, Raffles Medical Group has a market capitalization of S$1.75b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Raffles Medical Group has virtually no net debt, so it's fair to say it does not have a heavy debt load!
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Raffles Medical Group's net debt is only 0.23 times its EBITDA. And its EBIT covers its interest expense a whopping 362 times over. So we're pretty relaxed about its super-conservative use of debt. While Raffles Medical Group doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Raffles Medical Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Raffles Medical Group produced sturdy free cash flow equating to 56% 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.
Happily, Raffles Medical Group's impressive interest cover implies it has the upper hand on its debt. And its net debt to EBITDA is good too. We would also note that Healthcare industry companies like Raffles Medical Group commonly do use debt without problems. Taking all this data into account, it seems to us that Raffles Medical Group takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Raffles Medical Group's earnings per share history for free.
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.
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