Is EC Healthcare (HKG:2138) 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.' 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, EC Healthcare (HKG:2138) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for EC Healthcare

What Is EC Healthcare's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2023 EC Healthcare had debt of HK$719.1m, up from HK$235.7m in one year. But it also has HK$760.2m in cash to offset that, meaning it has HK$41.1m net cash.

A Look At EC Healthcare's Liabilities

We can see from the most recent balance sheet that EC Healthcare had liabilities of HK$1.68b falling due within a year, and liabilities of HK$1.47b due beyond that. Offsetting this, it had HK$760.2m in cash and HK$244.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$2.14b.

While this might seem like a lot, it is not so bad since EC Healthcare has a market capitalization of HK$4.92b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, EC Healthcare boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that EC Healthcare's EBIT was down 64% 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if EC Healthcare 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, a company can only pay off debt with cold hard cash, not accounting profits. While EC Healthcare has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, EC Healthcare actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although EC Healthcare's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$41.1m. The cherry on top was that in converted 158% of that EBIT to free cash flow, bringing in HK$193m. So although we see some areas for improvement, we're not too worried about EC Healthcare's balance sheet. 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. For example - EC Healthcare has 2 warning signs we think you should be aware of.

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.