Clínica Las Condes (SNSE:LAS CONDES) Takes On Some Risk With Its Use Of Debt

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 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. Importantly, Clínica Las Condes S.A. (SNSE:LAS CONDES) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Clínica Las Condes

How Much Debt Does Clínica Las Condes Carry?

The chart below, which you can click on for greater detail, shows that Clínica Las Condes had CL$201.9b in debt in September 2020; about the same as the year before. However, because it has a cash reserve of CL$32.2b, its net debt is less, at about CL$169.7b.

How Strong Is Clínica Las Condes' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Clínica Las Condes had liabilities of CL$62.8b due within 12 months and liabilities of CL$241.4b due beyond that. Offsetting these obligations, it had cash of CL$32.2b as well as receivables valued at CL$95.7b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$176.3b.

This deficit is considerable relative to its market capitalization of CL$199.5b, so it does suggest shareholders should keep an eye on Clínica Las Condes' 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.

Weak interest cover of 0.15 times and a disturbingly high net debt to EBITDA ratio of 13.8 hit our confidence in Clínica Las Condes like a one-two punch to the gut. The debt burden here is substantial. Even worse, Clínica Las Condes saw its EBIT tank 95% over the last 12 months. 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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Clínica Las Condes will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Clínica Las Condes actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both Clínica Las Condes's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We should also note that Healthcare industry companies like Clínica Las Condes commonly do use debt without problems. Overall, we think it's fair to say that Clínica Las Condes has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. Be aware that Clínica Las Condes is showing 2 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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