Here's Why Sienna Senior Living (TSE:SIA) Can Manage Its Debt Responsibly

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 can see that Sienna Senior Living Inc. (TSE:SIA) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Sienna Senior Living

What Is Sienna Senior Living's Debt?

The chart below, which you can click on for greater detail, shows that Sienna Senior Living had CA$1.01b in debt in March 2024; about the same as the year before. However, it does have CA$25.7m in cash offsetting this, leading to net debt of about CA$982.4m.

How Healthy Is Sienna Senior Living's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sienna Senior Living had liabilities of CA$535.8m due within 12 months and liabilities of CA$787.9m due beyond that. On the other hand, it had cash of CA$25.7m and CA$22.2m worth of receivables due within a year. So its liabilities total CA$1.28b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's CA$1.10b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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).

Weak interest cover of 2.1 times and a disturbingly high net debt to EBITDA ratio of 7.1 hit our confidence in Sienna Senior Living like a one-two punch to the gut. The debt burden here is substantial. Looking on the bright side, Sienna Senior Living boosted its EBIT by a silky 57% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. 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 Sienna Senior Living'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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Sienna Senior Living generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Sienna Senior Living's net debt to EBITDA was a real negative on this analysis, as was its interest cover. But its conversion of EBIT to free cash flow was significantly redeeming. It's also worth noting that Sienna Senior Living is in the Healthcare industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about Sienna Senior Living's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Sienna Senior Living that you should be aware of before investing here.

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.