Is Humanwell Healthcare (Group)Ltd (SHSE:600079) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Humanwell Healthcare (Group) Co.,Ltd. (SHSE:600079) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Humanwell Healthcare (Group)Ltd

How Much Debt Does Humanwell Healthcare (Group)Ltd Carry?

As you can see below, Humanwell Healthcare (Group)Ltd had CN¥9.47b of debt at September 2024, down from CN¥10.1b a year prior. However, it also had CN¥4.76b in cash, and so its net debt is CN¥4.71b.

How Strong Is Humanwell Healthcare (Group)Ltd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Humanwell Healthcare (Group)Ltd had liabilities of CN¥13.7b due within 12 months and liabilities of CN¥2.60b due beyond that. Offsetting these obligations, it had cash of CN¥4.76b as well as receivables valued at CN¥11.0b due within 12 months. So it has liabilities totalling CN¥543.3m more than its cash and near-term receivables, combined.

Having regard to Humanwell Healthcare (Group)Ltd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥37.6b company is short on cash, but still worth keeping an eye on the balance sheet.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Humanwell Healthcare (Group)Ltd has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 17.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, Humanwell Healthcare (Group)Ltd grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Humanwell Healthcare (Group)Ltd'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, 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. Over the last three years, Humanwell Healthcare (Group)Ltd reported free cash flow worth 9.0% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

The good news is that Humanwell Healthcare (Group)Ltd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Humanwell Healthcare (Group)Ltd can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. To that end, you should be aware of the 1 warning sign we've spotted with Humanwell Healthcare (Group)Ltd .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.