IHH Healthcare Berhad (KLSE:IHH) Has A Rock Solid Balance Sheet

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.' 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 IHH Healthcare Berhad (KLSE:IHH) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that IHH is potentially undervalued!

What Is IHH Healthcare Berhad's Net Debt?

As you can see below, IHH Healthcare Berhad had RM7.89b of debt at June 2022, down from RM9.01b a year prior. However, because it has a cash reserve of RM4.47b, its net debt is less, at about RM3.42b.

How Healthy Is IHH Healthcare Berhad's Balance Sheet?

We can see from the most recent balance sheet that IHH Healthcare Berhad had liabilities of RM6.15b falling due within a year, and liabilities of RM11.4b due beyond that. On the other hand, it had cash of RM4.47b and RM2.49b worth of receivables due within a year. So it has liabilities totalling RM10.6b more than its cash and near-term receivables, combined.

This deficit isn't so bad because IHH Healthcare Berhad is worth a massive RM51.6b, and thus could probably raise enough capital to shore up 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

IHH Healthcare Berhad has net debt of just 0.85 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.6 times, which is more than adequate. Also positive, IHH Healthcare Berhad grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. 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 IHH Healthcare Berhad'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, IHH Healthcare Berhad recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Happily, IHH Healthcare Berhad's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! We would also note that Healthcare industry companies like IHH Healthcare Berhad commonly do use debt without problems. Overall, we don't think IHH Healthcare Berhad is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. 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 IHH Healthcare Berhad's earnings per share history for free.

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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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.