Oncoclínicas do Brasil Serviços Médicos (BVMF:ONCO3) Has A Somewhat Strained Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Oncoclínicas do Brasil Serviços Médicos S.A. (BVMF:ONCO3) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Oncoclínicas do Brasil Serviços Médicos

What Is Oncoclínicas do Brasil Serviços Médicos's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Oncoclínicas do Brasil Serviços Médicos had R$3.23b of debt, an increase on R$2.64b, over one year. However, it also had R$590.7m in cash, and so its net debt is R$2.64b.

How Healthy Is Oncoclínicas do Brasil Serviços Médicos' Balance Sheet?

According to the last reported balance sheet, Oncoclínicas do Brasil Serviços Médicos had liabilities of R$1.82b due within 12 months, and liabilities of R$4.14b due beyond 12 months. On the other hand, it had cash of R$590.7m and R$1.86b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$3.51b.

This deficit is considerable relative to its market capitalization of R$5.25b, so it does suggest shareholders should keep an eye on Oncoclínicas do Brasil Serviços Médicos' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Oncoclínicas do Brasil Serviços Médicos's debt to EBITDA ratio (2.8) suggests that it uses some debt, its interest cover is very weak, at 1.7, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. The silver lining is that Oncoclínicas do Brasil Serviços Médicos grew its EBIT by 121% 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Oncoclínicas do Brasil Serviços Médicos can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Oncoclínicas do Brasil Serviços Médicos 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

Oncoclínicas do Brasil Serviços Médicos's conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. We should also note that Healthcare industry companies like Oncoclínicas do Brasil Serviços Médicos commonly do use debt without problems. Taking the abovementioned factors together we do think Oncoclínicas do Brasil Serviços Médicos's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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, we've discovered 2 warning signs for Oncoclínicas do Brasil Serviços Médicos (1 shouldn't be ignored!) that you should be aware of before investing here.

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.