Is CHC Healthcare Group (TPE:4164) Using Too Much Debt?

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. As with many other companies CHC Healthcare Group (TPE:4164) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 CHC Healthcare Group

How Much Debt Does CHC Healthcare Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 CHC Healthcare Group had NT$5.72b of debt, an increase on NT$4.72b, over one year. However, it does have NT$2.78b in cash offsetting this, leading to net debt of about NT$2.94b.

How Healthy Is CHC Healthcare Group's Balance Sheet?

The latest balance sheet data shows that CHC Healthcare Group had liabilities of NT$1.97b due within a year, and liabilities of NT$4.96b falling due after that. Offsetting these obligations, it had cash of NT$2.78b as well as receivables valued at NT$1.18b due within 12 months. So its liabilities total NT$2.96b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because CHC Healthcare Group is worth NT$5.76b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CHC Healthcare Group has net debt to EBITDA of 3.1 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 9.8 times its interest expense, and its net debt to EBITDA, was quite high, at 3.1. Notably CHC Healthcare Group's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. When analysing debt levels, the balance sheet is the obvious place to start. But it is CHC Healthcare Group's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, CHC Healthcare Group recorded free cash flow worth 50% 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

On our analysis CHC Healthcare Group's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit handle its debt, based on its EBITDA,. We would also note that Healthcare industry companies like CHC Healthcare Group commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about CHC Healthcare Group's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with CHC Healthcare Group (including 1 which is a bit unpleasant) .

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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