Does Instituto Hermes Pardini (BVMF:PARD3) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Instituto Hermes Pardini S.A. (BVMF:PARD3) does carry debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Instituto Hermes Pardini

How Much Debt Does Instituto Hermes Pardini Carry?

As you can see below, at the end of June 2020, Instituto Hermes Pardini had R$430.2m of debt, up from R$234.8m a year ago. Click the image for more detail. On the flip side, it has R$291.9m in cash leading to net debt of about R$138.3m.

A Look At Instituto Hermes Pardini's Liabilities

The latest balance sheet data shows that Instituto Hermes Pardini had liabilities of R$428.4m due within a year, and liabilities of R$721.1m falling due after that. Offsetting this, it had R$291.9m in cash and R$280.9m in receivables that were due within 12 months. So its liabilities total R$576.7m more than the combination of its cash and short-term receivables.

Given Instituto Hermes Pardini has a market capitalization of R$3.40b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 0.71 and interest cover of 5.7 times, it seems to us that Instituto Hermes Pardini is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Unfortunately, Instituto Hermes Pardini's EBIT flopped 16% over the last four quarters. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Instituto Hermes Pardini 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Instituto Hermes Pardini produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Based on what we've seen Instituto Hermes Pardini is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. We would also note that Healthcare industry companies like Instituto Hermes Pardini commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Instituto Hermes Pardini is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Instituto Hermes Pardini , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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