The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Green Cross Health Limited (NZSE:GXH) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Green Cross Health
How Much Debt Does Green Cross Health Carry?
The chart below, which you can click on for greater detail, shows that Green Cross Health had NZ$24.0m in debt in March 2022; about the same as the year before. However, it does have NZ$45.2m in cash offsetting this, leading to net cash of NZ$21.1m.
How Strong Is Green Cross Health's Balance Sheet?
We can see from the most recent balance sheet that Green Cross Health had liabilities of NZ$133.6m falling due within a year, and liabilities of NZ$101.2m due beyond that. Offsetting these obligations, it had cash of NZ$45.2m as well as receivables valued at NZ$47.3m due within 12 months. So it has liabilities totalling NZ$142.4m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of NZ$190.4m, so it does suggest shareholders should keep an eye on Green Cross Health's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Green Cross Health also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, Green Cross Health grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. 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 Green Cross Health will need earnings to service that debt. 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Green Cross Health may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Green Cross Health actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While Green Cross Health does have more liabilities than liquid assets, it also has net cash of NZ$21.1m. And it impressed us with free cash flow of NZ$62m, being 144% of its EBIT. So we don't think Green Cross Health's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Green Cross Health has 1 warning sign we think you should be aware of.
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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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.