Health Italia (BIT:HI) 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. We can see that Health Italia S.p.A. (BIT:HI) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for Health Italia

How Much Debt Does Health Italia Carry?

You can click the graphic below for the historical numbers, but it shows that Health Italia had €10.1m of debt in June 2023, down from €16.9m, one year before. On the flip side, it has €4.44m in cash leading to net debt of about €5.64m.

How Healthy Is Health Italia's Balance Sheet?

According to the last reported balance sheet, Health Italia had liabilities of €23.8m due within 12 months, and liabilities of €10.9m due beyond 12 months. Offsetting these obligations, it had cash of €4.44m as well as receivables valued at €30.8m due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Health Italia's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the €27.4m company is short on cash, but still worth keeping an eye on the balance sheet.

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). 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).

With net debt sitting at just 0.81 times EBITDA, Health Italia is arguably pretty conservatively geared. And it boasts interest cover of 7.4 times, which is more than adequate. On the other hand, Health Italia's EBIT dived 17%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Health Italia'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Health Italia created free cash flow amounting to 18% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Based on what we've seen Health Italia is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that it has an adequate capacity handle its debt, based on its EBITDA,. We would also note that Healthcare industry companies like Health Italia commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Health Italia's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Health Italia has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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. 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.