Is LYC Healthcare Berhad (KLSE:LYC) A Risky Investment?

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.' 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. We can see that LYC Healthcare Berhad (KLSE:LYC) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for LYC Healthcare Berhad

What Is LYC Healthcare Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that LYC Healthcare Berhad had RM69.8m of debt in December 2022, down from RM87.7m, one year before. On the flip side, it has RM37.7m in cash leading to net debt of about RM32.1m.

A Look At LYC Healthcare Berhad's Liabilities

According to the last reported balance sheet, LYC Healthcare Berhad had liabilities of RM39.7m due within 12 months, and liabilities of RM95.3m due beyond 12 months. Offsetting this, it had RM37.7m in cash and RM15.7m in receivables that were due within 12 months. So its liabilities total RM81.7m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since LYC Healthcare Berhad has a market capitalization of RM145.5m, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While we wouldn't worry about LYC Healthcare Berhad's net debt to EBITDA ratio of 2.5, we think its super-low interest cover of 0.87 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Pleasingly, LYC Healthcare Berhad is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 108% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since LYC Healthcare Berhad 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last two years, LYC Healthcare Berhad generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, LYC Healthcare Berhad's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its interest cover has the opposite effect. Looking at all the aforementioned factors together, it strikes us that LYC Healthcare Berhad can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with LYC Healthcare Berhad (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

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.