Diagnósticos da América (BVMF:DASA3) Seems To Be Using A Lot Of Debt

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 note that Diagnósticos da América S.A. (BVMF:DASA3) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Diagnósticos da América

How Much Debt Does Diagnósticos da América Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Diagnósticos da América had debt of R$10.0b, up from R$5.37b in one year. On the flip side, it has R$1.01b in cash leading to net debt of about R$9.01b.

How Healthy Is Diagnósticos da América's Balance Sheet?

According to the last reported balance sheet, Diagnósticos da América had liabilities of R$5.57b due within 12 months, and liabilities of R$12.2b due beyond 12 months. Offsetting this, it had R$1.01b in cash and R$4.00b in receivables that were due within 12 months. So its liabilities total R$12.7b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the R$4.41b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Diagnósticos da América would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Diagnósticos da América shareholders face the double whammy of a high net debt to EBITDA ratio (6.5), and fairly weak interest coverage, since EBIT is just 0.73 times the interest expense. This means we'd consider it to have a heavy debt load. However, it should be some comfort for shareholders to recall that Diagnósticos da América actually grew its EBIT by a hefty 390%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Diagnósticos da América's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Diagnósticos da América saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Diagnósticos da América's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We should also note that Healthcare industry companies like Diagnósticos da América commonly do use debt without problems. We're quite clear that we consider Diagnósticos da América to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Diagnósticos da América that you should be aware of before investing here.

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.

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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.