Rici Healthcare Holdings (HKG:1526) Has A Somewhat Strained Balance Sheet

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 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 Rici Healthcare Holdings Limited (HKG:1526) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Rici Healthcare Holdings

What Is Rici Healthcare Holdings's Net Debt?

As you can see below, at the end of June 2021, Rici Healthcare Holdings had CN¥1.40b of debt, up from CN¥1.23b a year ago. Click the image for more detail. However, it also had CN¥492.0m in cash, and so its net debt is CN¥911.0m.

A Look At Rici Healthcare Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Rici Healthcare Holdings had liabilities of CN¥1.92b due within 12 months and liabilities of CN¥1.93b due beyond that. On the other hand, it had cash of CN¥492.0m and CN¥309.0m worth of receivables due within a year. So it has liabilities totalling CN¥3.05b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥1.57b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Rici Healthcare Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Rici Healthcare Holdings has a quite reasonable net debt to EBITDA multiple of 2.0, its interest cover seems weak, at 1.9. This does have us wondering if the company pays high interest because it is considered risky. Either way there's no doubt the stock is using meaningful leverage. Notably, Rici Healthcare Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥298m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Rici Healthcare Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Rici Healthcare Holdings generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

On the face of it, Rici Healthcare Holdings's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. It's also worth noting that Rici Healthcare Holdings is in the Healthcare industry, which is often considered to be quite defensive. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Rici Healthcare Holdings stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Rici Healthcare Holdings (1 is potentially serious) 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.

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.

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