Hapvida Participações e Investimentos (BVMF:HAPV3) Has A Pretty Healthy Balance Sheet

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 note that Hapvida Participações e Investimentos S.A. (BVMF:HAPV3) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hapvida Participações e Investimentos

What Is Hapvida Participações e Investimentos's Debt?

The image below, which you can click on for greater detail, shows that Hapvida Participações e Investimentos had debt of R$11.0b at the end of March 2024, a reduction from R$11.9b over a year. However, because it has a cash reserve of R$6.94b, its net debt is less, at about R$4.06b.

How Healthy Is Hapvida Participações e Investimentos' Balance Sheet?

The latest balance sheet data shows that Hapvida Participações e Investimentos had liabilities of R$7.80b due within a year, and liabilities of R$17.8b falling due after that. Offsetting these obligations, it had cash of R$6.94b as well as receivables valued at R$2.14b due within 12 months. So it has liabilities totalling R$16.6b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Hapvida Participações e Investimentos has a market capitalization of R$30.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Hapvida Participações e Investimentos has a very low debt to EBITDA ratio of 1.3 so it is strange to see weak interest coverage, with last year's EBIT being only 1.1 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. We also note that Hapvida Participações e Investimentos improved its EBIT from a last year's loss to a positive R$1.8b. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hapvida Participações e Investimentos'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Hapvida Participações e Investimentos actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Based on what we've seen Hapvida Participações e Investimentos is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. We would also note that Healthcare industry companies like Hapvida Participações e Investimentos commonly do use debt without problems. Considering this range of data points, we think Hapvida Participações e Investimentos is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Even though Hapvida Participações e Investimentos lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

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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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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