These 4 Measures Indicate That Sienna Senior Living (TSE:SIA) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Sienna Senior Living

How Much Debt Does Sienna Senior Living Carry?

The chart below, which you can click on for greater detail, shows that Sienna Senior Living had CA$1.00b in debt in June 2024; about the same as the year before. On the flip side, it has CA$25.0m in cash leading to net debt of about CA$977.8m.

A Look At Sienna Senior Living's Liabilities

Zooming in on the latest balance sheet data, we can see that Sienna Senior Living had liabilities of CA$566.5m due within 12 months and liabilities of CA$780.2m due beyond that. Offsetting these obligations, it had cash of CA$25.0m as well as receivables valued at CA$21.2m due within 12 months. So it has liabilities totalling CA$1.30b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CA$1.43b, so it does suggest shareholders should keep an eye on Sienna Senior Living's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sienna Senior Living shareholders face the double whammy of a high net debt to EBITDA ratio (6.9), and fairly weak interest coverage, since EBIT is just 2.2 times the interest expense. This means we'd consider it to have a heavy debt load. Looking on the bright side, Sienna Senior Living boosted its EBIT by a silky 62% 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 ultimately the future profitability of the business will decide if Sienna Senior Living 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Sienna Senior Living produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Sienna Senior Living's net debt to EBITDA was a real negative on this analysis, as was its interest cover. But like a ballerina ending on a perfect pirouette, it has not trouble growing its EBIT. We would also note that Healthcare industry companies like Sienna Senior Living commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Sienna Senior Living's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Sienna Senior Living (of which 2 make us uncomfortable!) you should know about.

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.