Auditors Have Doubts About Advanced Health (JSE:AVL)

The harsh reality for Advanced Health Limited (JSE:AVL) shareholders is that its auditors, Mazars, expressed doubts about its ability to continue as a going concern, in its reported results to June 2022. This means that, based on the financial results to that date, the company arguably should raise capital, or otherwise strengthen the balance sheet, as soon as possible.

Since the company probably needs cash fairly quickly, it may be in a position where it has to accept whatever terms it can get. So it is suddenly extremely important to consider whether the company is taking too much risk on its balance sheet. The biggest concern we would have is the company's debt, since its lenders might force the company into administration if it cannot repay them.

View our latest analysis for Advanced Health

What Is Advanced Health's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Advanced Health had debt of R221.3m, up from R204.0m in one year. On the flip side, it has R129.7m in cash leading to net debt of about R91.6m.

How Strong Is Advanced Health's Balance Sheet?

According to the last reported balance sheet, Advanced Health had liabilities of R179.4m due within 12 months, and liabilities of R683.4m due beyond 12 months. Offsetting this, it had R129.7m in cash and R55.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R677.3m.

This deficit casts a shadow over the R114.7m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Advanced Health would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Advanced Health has a very low debt to EBITDA ratio of 0.68 so it is strange to see weak interest coverage, with last year's EBIT being only 1.2 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Importantly, Advanced Health's EBIT fell a jaw-dropping 32% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Advanced Health'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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Advanced Health actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both Advanced Health's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the bigger picture, it seems clear to us that Advanced Health's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. Despite being in the defensive Healthcare industry, we would still avoid Advanced Health because of its riskiness and because of the auditor's view. 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. For example - Advanced Health has 3 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.