These 4 Measures Indicate That Yestar Healthcare Holdings (HKG:2393) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Yestar Healthcare Holdings Company Limited (HKG:2393) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Yestar Healthcare Holdings

What Is Yestar Healthcare Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Yestar Healthcare Holdings had CN¥1.65b in debt in December 2020; about the same as the year before. However, it does have CN¥687.1m in cash offsetting this, leading to net debt of about CN¥959.3m.

How Strong Is Yestar Healthcare Holdings' Balance Sheet?

According to the last reported balance sheet, Yestar Healthcare Holdings had liabilities of CN¥3.29b due within 12 months, and liabilities of CN¥511.1m due beyond 12 months. Offsetting this, it had CN¥687.1m in cash and CN¥1.47b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.64b.

This is a mountain of leverage relative to its market capitalization of CN¥2.30b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

While Yestar Healthcare Holdings's debt to EBITDA ratio (2.8) suggests that it uses some debt, its interest cover is very weak, at 1.6, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Yestar Healthcare Holdings's EBIT was down 70% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Yestar Healthcare Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Yestar Healthcare Holdings's free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both Yestar Healthcare Holdings's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its conversion of EBIT to free cash flow is not so bad. It's also worth noting that Yestar Healthcare Holdings is in the Medical Equipment industry, which is often considered to be quite defensive. We're quite clear that we consider Yestar Healthcare Holdings to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Yestar Healthcare Holdings has 2 warning signs we think 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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