Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Centrum Medyczne ENEL-MED S.A. (WSE:ENE) 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. 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. 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.
How Much Debt Does Centrum Medyczne ENEL-MED Carry?
The image below, which you can click on for greater detail, shows that Centrum Medyczne ENEL-MED had debt of zł29.5m at the end of September 2020, a reduction from zł43.1m over a year. However, it does have zł32.9m in cash offsetting this, leading to net cash of zł3.40m.
A Look At Centrum Medyczne ENEL-MED's Liabilities
The latest balance sheet data shows that Centrum Medyczne ENEL-MED had liabilities of zł100.0m due within a year, and liabilities of zł204.1m falling due after that. Offsetting these obligations, it had cash of zł32.9m as well as receivables valued at zł19.4m due within 12 months. So it has liabilities totalling zł251.8m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of zł384.1m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Centrum Medyczne ENEL-MED boasts net cash, so it's fair to say it does not have a heavy debt load!
Pleasingly, Centrum Medyczne ENEL-MED is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 503% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Centrum Medyczne ENEL-MED's earnings that will influence how the balance sheet holds up in the future. 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. While Centrum Medyczne ENEL-MED has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Centrum Medyczne ENEL-MED actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Although Centrum Medyczne ENEL-MED's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of zł3.40m. And it impressed us with free cash flow of zł76m, being 594% of its EBIT. So we don't have any problem with Centrum Medyczne ENEL-MED's use of 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 Centrum Medyczne ENEL-MED has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.
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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