Is Inspiration Healthcare Group (LON:IHC) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Inspiration Healthcare Group plc (LON:IHC) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Inspiration Healthcare Group

What Is Inspiration Healthcare Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of July 2023 Inspiration Healthcare Group had UK£4.00m of debt, an increase on none, over one year. However, it also had UK£1.95m in cash, and so its net debt is UK£2.05m.

How Strong Is Inspiration Healthcare Group's Balance Sheet?

According to the last reported balance sheet, Inspiration Healthcare Group had liabilities of UK£8.07m due within 12 months, and liabilities of UK£9.85m due beyond 12 months. On the other hand, it had cash of UK£1.95m and UK£9.45m worth of receivables due within a year. So it has liabilities totalling UK£6.52m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Inspiration Healthcare Group is worth UK£31.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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

Given net debt is only 1.3 times EBITDA, it is initially surprising to see that Inspiration Healthcare Group's EBIT has low interest coverage of 0.86 times. So one way or the other, it's clear the debt levels are not trivial. Shareholders should be aware that Inspiration Healthcare Group's EBIT was down 86% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Inspiration Healthcare Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Inspiration Healthcare Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Inspiration Healthcare Group's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. We should also note that Medical Equipment industry companies like Inspiration Healthcare Group commonly do use debt without problems. Overall, we think it's fair to say that Inspiration Healthcare Group has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Case in point: We've spotted 1 warning sign for Inspiration Healthcare Group you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.