Is Hospital Corporation of China (HKG:3869) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Hospital Corporation of China Limited (HKG:3869) makes use of debt. But the more important question is: how much risk is that debt creating?

Our free stock report includes 1 warning sign investors should be aware of before investing in Hospital Corporation of China. Read for free now.

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Hospital Corporation of China Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Hospital Corporation of China had CN¥1.14b of debt, an increase on CN¥1.02b, over one year. On the flip side, it has CN¥813.1m in cash leading to net debt of about CN¥329.3m.

How Strong Is Hospital Corporation of China's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hospital Corporation of China had liabilities of CN¥1.81b due within 12 months and liabilities of CN¥196.6m due beyond that. Offsetting this, it had CN¥813.1m in cash and CN¥254.6m in receivables that were due within 12 months. So its liabilities total CN¥939.8m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥688.4m, we think shareholders really should watch Hospital Corporation of China's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

See our latest analysis for Hospital Corporation of China

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.

Hospital Corporation of China has a low debt to EBITDA ratio of only 1.4. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. In addition to that, we're happy to report that Hospital Corporation of China has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hospital Corporation of China will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Hospital Corporation of China 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.

Our View

Happily, Hospital Corporation of China's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its level of total liabilities has the opposite effect. It's also worth noting that Hospital Corporation of China is in the Healthcare industry, which is often considered to be quite defensive. All these things considered, it appears that Hospital Corporation of China can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Hospital Corporation of China is showing 1 warning sign in our investment analysis , you should know about...

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.