Stock Analysis

These 4 Measures Indicate That Tenet Healthcare (NYSE:THC) Is Using Debt Extensively

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NYSE:THC
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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Tenet Healthcare Corporation (NYSE:THC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Tenet Healthcare

How Much Debt Does Tenet Healthcare Carry?

The chart below, which you can click on for greater detail, shows that Tenet Healthcare had US$15.4b in debt in December 2021; about the same as the year before. However, because it has a cash reserve of US$2.36b, its net debt is less, at about US$13.0b.

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NYSE:THC Debt to Equity History March 28th 2022

How Healthy Is Tenet Healthcare's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tenet Healthcare had liabilities of US$5.11b due within 12 months and liabilities of US$18.2b due beyond that. On the other hand, it had cash of US$2.36b and US$3.37b worth of receivables due within a year. So its liabilities total US$17.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$9.61b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Tenet Healthcare would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Tenet Healthcare's debt is 3.8 times its EBITDA, and its EBIT cover its interest expense 2.8 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The good news is that Tenet Healthcare grew its EBIT a smooth 63% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Tenet Healthcare's ability to maintain a healthy balance sheet going forward. 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. During the last three years, Tenet Healthcare produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Tenet Healthcare's level of total liabilities and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. It's also worth noting that Tenet Healthcare is in the Healthcare industry, which is often considered to be quite defensive. Taking the abovementioned factors together we do think Tenet Healthcare's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. For example Tenet Healthcare has 3 warning signs (and 2 which are significant) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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