IHH Healthcare Berhad (KLSE:IHH) Takes On Some Risk With Its Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, IHH Healthcare Berhad (KLSE:IHH) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for IHH Healthcare Berhad

How Much Debt Does IHH Healthcare Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 IHH Healthcare Berhad had RM9.76b of debt, an increase on RM9.08b, over one year. However, it also had RM4.59b in cash, and so its net debt is RM5.17b.

A Look At IHH Healthcare Berhad's Liabilities

According to the last reported balance sheet, IHH Healthcare Berhad had liabilities of RM6.02b due within 12 months, and liabilities of RM11.6b due beyond 12 months. On the other hand, it had cash of RM4.59b and RM2.06b worth of receivables due within a year. So its liabilities total RM11.0b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because IHH Healthcare Berhad is worth a massive RM50.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

IHH Healthcare Berhad's net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 3.3 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, IHH Healthcare Berhad's EBIT fell a jaw-dropping 26% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if IHH Healthcare Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, IHH Healthcare Berhad produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

IHH Healthcare Berhad's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its conversion of EBIT to free cash flow was re-invigorating. We should also note that Healthcare industry companies like IHH Healthcare Berhad commonly do use debt without problems. Looking at all the angles mentioned above, it does seem to us that IHH Healthcare Berhad is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Given our hesitation about the stock, it would be good to know if IHH Healthcare Berhad insiders have sold any shares recently. You click here to find out if insiders have sold recently.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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