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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. As with many other companies. Medicover AB (publ) (STO:MCOV B) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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.
What Is Medicover’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Medicover had €146.7m of debt, an increase on €57.8m, over one year. However, it does have €48.8m in cash offsetting this, leading to net debt of about €97.9m.
How Strong Is Medicover’s Balance Sheet?
According to the last reported balance sheet, Medicover had liabilities of €137.3m due within 12 months, and liabilities of €313.9m due beyond 12 months. Offsetting these obligations, it had cash of €48.8m as well as receivables valued at €99.3m due within 12 months. So it has liabilities totalling €303.1m more than its cash and near-term receivables, combined.
Medicover has a market capitalization of €1.10b, so it could very likely ameliorate its balance sheet if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Because it carries more debt than cash, we think it’s worth watching Medicover’s balance sheet over time.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Medicover’s net debt to EBITDA ratio of about 1.58 suggests only moderate use of debt. And its commanding EBIT of 11.7 times its interest expense, implies the debt load is as light as a peacock feather. Medicover grew its EBIT by 2.3% in the last year. That’s far from incredible but it is a good thing, when it comes to paying off debt. 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 Medicover 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Medicover created free cash flow amounting to 14% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks some a little paranoia about is ability to extinguish debt.
On our analysis Medicover’s interest cover should signal that it won’t have too much trouble with its debt. However, our other observations weren’t so heartening. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. We would also note that Healthcare industry companies like Medicover commonly do use debt without problems. Looking at all this data makes us feel a little cautious about Medicover’s debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. We’d be motivated to research the stock further if we found out that Medicover insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions 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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.