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 Quantum Health Group Limited (ASX:QTM) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Quantum Health Group's Net Debt?
The image below, which you can click on for greater detail, shows that Quantum Health Group had debt of AU$7.35m at the end of June 2021, a reduction from AU$8.89m over a year. But on the other hand it also has AU$13.1m in cash, leading to a AU$5.77m net cash position.
How Strong Is Quantum Health Group's Balance Sheet?
According to the last reported balance sheet, Quantum Health Group had liabilities of AU$26.2m due within 12 months, and liabilities of AU$898.0k due beyond 12 months. Offsetting this, it had AU$13.1m in cash and AU$14.8m in receivables that were due within 12 months. So it can boast AU$833.0k more liquid assets than total liabilities.
Having regard to Quantum Health Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the AU$83.5m company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Quantum Health Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Quantum Health Group grew its EBIT at 12% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Quantum Health Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Quantum Health Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Quantum Health Group produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case Quantum Health Group has AU$5.77m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of AU$6.9m, being 80% of its EBIT. So is Quantum Health Group's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Quantum Health Group has 2 warning signs we think you should be aware of.
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.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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