Is Humanwell Healthcare (Group)Ltd (SHSE:600079) Using Too Much 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Humanwell Healthcare (Group) Co.,Ltd. (SHSE:600079) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

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

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

You can click the graphic below for the historical numbers, but it shows that Humanwell Healthcare (Group)Ltd had CN¥9.48b of debt in June 2024, down from CN¥9.91b, one year before. However, because it has a cash reserve of CN¥4.58b, its net debt is less, at about CN¥4.90b.

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

We can see from the most recent balance sheet that Humanwell Healthcare (Group)Ltd had liabilities of CN¥13.4b falling due within a year, and liabilities of CN¥2.90b due beyond that. On the other hand, it had cash of CN¥4.58b and CN¥10.4b worth of receivables due within a year. So it has liabilities totalling CN¥1.32b more than its cash and near-term receivables, combined.

Given Humanwell Healthcare (Group)Ltd has a market capitalization of CN¥25.9b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Humanwell Healthcare (Group)Ltd's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 14.2 times the size. So we're pretty relaxed about its super-conservative use of debt. Also good is that Humanwell Healthcare (Group)Ltd grew its EBIT at 10% over the last year, further increasing its ability to manage 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 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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Humanwell Healthcare (Group)Ltd created free cash flow amounting to 5.7% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

When it comes to the balance sheet, the standout positive for Humanwell Healthcare (Group)Ltd was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. To be specific, it seems about as good at converting EBIT to free cash flow as wet socks are at keeping your feet warm. When we consider all the elements mentioned above, it seems to us that Humanwell Healthcare (Group)Ltd is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Humanwell Healthcare (Group)Ltd has 1 warning sign we think you should be aware of.

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.

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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.