Alliança Saúde e Participações (BVMF:AALR3) Seems To Use Debt Quite Sensibly

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.' 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. Importantly, Alliança Saúde e Participações S.A. (BVMF:AALR3) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Alliança Saúde e Participações

What Is Alliança Saúde e Participações's Net Debt?

The image below, which you can click on for greater detail, shows that Alliança Saúde e Participações had debt of R$735.0m at the end of September 2024, a reduction from R$1.06b over a year. However, because it has a cash reserve of R$167.7m, its net debt is less, at about R$567.3m.

A Look At Alliança Saúde e Participações' Liabilities

Zooming in on the latest balance sheet data, we can see that Alliança Saúde e Participações had liabilities of R$625.4m due within 12 months and liabilities of R$826.0m due beyond that. On the other hand, it had cash of R$167.7m and R$273.0m worth of receivables due within a year. So it has liabilities totalling R$1.01b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of R$1.34b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Alliança Saúde e Participações shareholders face the double whammy of a high net debt to EBITDA ratio (5.3), and fairly weak interest coverage, since EBIT is just 0.39 times the interest expense. The debt burden here is substantial. The silver lining is that Alliança Saúde e Participações grew its EBIT by 476% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Alliança Saúde e Participações 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 always check how much of that EBIT is translated into free cash flow. Over the most recent two years, Alliança Saúde e Participações recorded free cash flow worth 62% 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.

Our View

We weren't impressed with Alliança Saúde e Participações's net debt to EBITDA, and its interest cover made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble growing its EBIT. We would also note that Healthcare industry companies like Alliança Saúde e Participações commonly do use debt without problems. Looking at all this data makes us feel a little cautious about Alliança Saúde e Participações's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Be aware that Alliança Saúde e Participações is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.