CM Hospitalar S/A (BVMF:VVEO3) Has No Shortage 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that CM Hospitalar S/A (BVMF:VVEO3) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for CM Hospitalar S/A

What Is CM Hospitalar S/A's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 CM Hospitalar S/A had R$3.89b of debt, an increase on R$3.32b, over one year. On the flip side, it has R$1.79b in cash leading to net debt of about R$2.10b.

How Strong Is CM Hospitalar S/A's Balance Sheet?

We can see from the most recent balance sheet that CM Hospitalar S/A had liabilities of R$2.70b falling due within a year, and liabilities of R$4.62b due beyond that. On the other hand, it had cash of R$1.79b and R$2.15b worth of receivables due within a year. So it has liabilities totalling R$3.38b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the R$644.2m 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. At the end of the day, CM Hospitalar S/A would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Weak interest cover of 0.073 times and a disturbingly high net debt to EBITDA ratio of 8.7 hit our confidence in CM Hospitalar S/A like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, CM Hospitalar S/A saw its EBIT tank 96% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine CM Hospitalar S/A'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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, CM Hospitalar S/A recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both CM Hospitalar S/A's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its net debt to EBITDA fails to inspire much confidence. It's also worth noting that CM Hospitalar S/A is in the Healthcare industry, which is often considered to be quite defensive. It looks to us like CM Hospitalar S/A carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. 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. We've identified 3 warning signs with CM Hospitalar S/A (at least 2 which are significant) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.