IHH Healthcare Berhad (KLSE:IHH) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies IHH Healthcare Berhad (KLSE:IHH) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for IHH Healthcare Berhad

What Is IHH Healthcare Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that IHH Healthcare Berhad had RM8.03b of debt in June 2024, down from RM9.32b, one year before. On the flip side, it has RM1.96b in cash leading to net debt of about RM6.08b.

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 RM7.48b falling due within a year, and liabilities of RM10.3b due beyond that. On the other hand, it had cash of RM1.96b and RM3.53b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM12.3b.

Given IHH Healthcare Berhad has a humongous market capitalization of RM62.6b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 1.0 times EBITDA, IHH Healthcare Berhad is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.1 times the interest expense over the last year. In addition to that, we're happy to report that IHH Healthcare Berhad has boosted its EBIT by 56%, thus reducing the spectre of future debt repayments. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, IHH Healthcare Berhad produced sturdy free cash flow equating to 54% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that IHH Healthcare Berhad's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. And its net debt to EBITDA is good too. It's also worth noting that IHH Healthcare Berhad is in the Healthcare industry, which is often considered to be quite defensive. Looking at the bigger picture, we think IHH Healthcare Berhad's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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.

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.