Hapvida Participações e Investimentos (BVMF:HAPV3) Has A Somewhat Strained Balance Sheet

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. As with many other companies Hapvida Participações e Investimentos S.A. (BVMF:HAPV3) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that HAPV3 is potentially overvalued!

What Is Hapvida Participações e Investimentos's Net Debt?

As you can see below, at the end of June 2022, Hapvida Participações e Investimentos had R$11.5b of debt, up from R$2.09b a year ago. Click the image for more detail. On the flip side, it has R$4.12b in cash leading to net debt of about R$7.40b.

How Strong Is Hapvida Participações e Investimentos' Balance Sheet?

According to the last reported balance sheet, Hapvida Participações e Investimentos had liabilities of R$6.75b due within 12 months, and liabilities of R$16.3b due beyond 12 months. On the other hand, it had cash of R$4.12b and R$1.62b worth of receivables due within a year. So its liabilities total R$17.3b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Hapvida Participações e Investimentos has a market capitalization of R$45.4b, 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.32 times and a disturbingly high net debt to EBITDA ratio of 5.8 hit our confidence in Hapvida Participações e Investimentos like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Hapvida Participações e Investimentos's EBIT was down 85% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Hapvida Participações e Investimentos recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On the face of it, Hapvida Participações e Investimentos's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. It's also worth noting that Hapvida Participações e Investimentos is in the Healthcare industry, which is often considered to be quite defensive. Overall, it seems to us that Hapvida Participações e Investimentos's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Case in point: We've spotted 2 warning signs for Hapvida Participações e Investimentos you should be aware of, and 1 of them doesn't sit too well with us.

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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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.