We Think Qianhai Health Holdings (HKG:911) Is Taking Some Risk With Its 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 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. As with many other companies Qianhai Health Holdings Limited (HKG:911) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Qianhai Health Holdings

What Is Qianhai Health Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Qianhai Health Holdings had debt of HK$22.7m at the end of December 2020, a reduction from HK$74.6m over a year. However, it also had HK$16.6m in cash, and so its net debt is HK$6.09m.

How Strong Is Qianhai Health Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Qianhai Health Holdings had liabilities of HK$61.6m due within 12 months and liabilities of HK$666.0k due beyond that. On the other hand, it had cash of HK$16.6m and HK$199.4m worth of receivables due within a year. So it can boast HK$153.7m more liquid assets than total liabilities.

This luscious liquidity implies that Qianhai Health Holdings' balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity.

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). 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).

Given net debt is only 1.4 times EBITDA, it is initially surprising to see that Qianhai Health Holdings's EBIT has low interest coverage of 1.4 times. So one way or the other, it's clear the debt levels are not trivial. Importantly, Qianhai Health Holdings's EBIT fell a jaw-dropping 79% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Qianhai Health Holdings 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, Qianhai Health Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Qianhai Health Holdings's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But its level of total liabilities tells a very different story, and suggests some resilience. We think that Qianhai Health Holdings's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 instance, we've identified 1 warning sign for Qianhai Health Holdings that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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