Wenzhou Kangning Hospital (HKG:2120) Has A Pretty Healthy 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Wenzhou Kangning Hospital Co., Ltd. (HKG:2120) does carry debt. But the real question is whether this debt is making the company risky.

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 Wenzhou Kangning Hospital

How Much Debt Does Wenzhou Kangning Hospital Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Wenzhou Kangning Hospital had CN¥434.9m of debt, an increase on CN¥314.5m, over one year. However, it also had CN¥206.5m in cash, and so its net debt is CN¥228.4m.

How Healthy Is Wenzhou Kangning Hospital's Balance Sheet?

According to the last reported balance sheet, Wenzhou Kangning Hospital had liabilities of CN¥599.1m due within 12 months, and liabilities of CN¥335.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥206.5m as well as receivables valued at CN¥384.8m due within 12 months. So it has liabilities totalling CN¥343.2m more than its cash and near-term receivables, combined.

Wenzhou Kangning Hospital has a market capitalization of CN¥1.57b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

While Wenzhou Kangning Hospital's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.9 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably, Wenzhou Kangning Hospital's EBIT launched higher than Elon Musk, gaining a whopping 148% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Wenzhou Kangning Hospital's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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, Wenzhou Kangning Hospital saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Wenzhou Kangning Hospital is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. We would also note that Healthcare industry companies like Wenzhou Kangning Hospital commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Wenzhou Kangning Hospital 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. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Wenzhou Kangning Hospital's earnings per share history for free.

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. 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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