Stock Analysis

Here's Why EMC Instytut Medyczny (WSE:EMC) Has A Meaningful Debt Burden

WSE:EMC
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, EMC Instytut Medyczny SA (WSE:EMC) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for EMC Instytut Medyczny

How Much Debt Does EMC Instytut Medyczny Carry?

You can click the graphic below for the historical numbers, but it shows that EMC Instytut Medyczny had zł57.7m of debt in December 2020, down from zł134.1m, one year before. However, it does have zł22.9m in cash offsetting this, leading to net debt of about zł34.9m.

debt-equity-history-analysis
WSE:EMC Debt to Equity History May 23rd 2021

A Look At EMC Instytut Medyczny's Liabilities

Zooming in on the latest balance sheet data, we can see that EMC Instytut Medyczny had liabilities of zł112.1m due within 12 months and liabilities of zł84.0m due beyond that. Offsetting this, it had zł22.9m in cash and zł47.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł126.3m.

This deficit isn't so bad because EMC Instytut Medyczny is worth zł306.2m, 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).

While EMC Instytut Medyczny has a quite reasonable net debt to EBITDA multiple of 2.3, its interest cover seems weak, at 0.43. The main reason for this is that it has such high depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) Either way there's no doubt the stock is using meaningful leverage. We also note that EMC Instytut Medyczny improved its EBIT from a last year's loss to a positive zł2.2m. 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 EMC Instytut Medyczny will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, EMC Instytut Medyczny saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, EMC Instytut Medyczny's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. It's also worth noting that EMC Instytut Medyczny is in the Healthcare industry, which is often considered to be quite defensive. Once we consider all the factors above, together, it seems to us that EMC Instytut Medyczny's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for EMC Instytut Medyczny that you should be aware of before investing here.

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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