Stock Analysis

EBOS Group (NZSE:EBO) Has A Pretty Healthy Balance Sheet

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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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, EBOS Group Limited (NZSE:EBO) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for EBOS Group

What Is EBOS Group's Debt?

The image below, which you can click on for greater detail, shows that EBOS Group had debt of AU$978.5m at the end of June 2023, a reduction from AU$1.38b over a year. However, it also had AU$225.5m in cash, and so its net debt is AU$753.0m.

NZSE:EBO Debt to Equity History October 2nd 2023

How Strong Is EBOS Group's Balance Sheet?

According to the last reported balance sheet, EBOS Group had liabilities of AU$2.66b due within 12 months, and liabilities of AU$1.48b due beyond 12 months. Offsetting these obligations, it had cash of AU$225.5m as well as receivables valued at AU$1.50b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.40b.

This deficit isn't so bad because EBOS Group is worth AU$6.31b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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

Looking at its net debt to EBITDA of 1.5 and interest cover of 6.3 times, it seems to us that EBOS Group is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Another good sign is that EBOS Group has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if EBOS Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. Over the most recent three years, EBOS Group recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that EBOS Group's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. And its conversion of EBIT to free cash flow is good too. It's also worth noting that EBOS Group is in the Healthcare industry, which is often considered to be quite defensive. Taking all this data into account, it seems to us that EBOS Group takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check EBOS Group's dividend history, without delay!

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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