Yahoo Finance These 4 Measures Indicate That Green Cross Health (NZSE:GXH) Is Using Debt Reasonably Well
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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Green Cross Health Limited (NZSE:GXH) does carry debt. But the real question is whether this debt is making the company risky.
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. 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.
Check out our latest analysis for Green Cross Health
What Is Green Cross Health's Debt?
You can click the graphic below for the historical numbers, but it shows that Green Cross Health had NZ$41.2m of debt in September 2020, down from NZ$50.0m, one year before. But it also has NZ$44.9m in cash to offset that, meaning it has NZ$3.75m net cash.
How Healthy Is Green Cross Health's Balance Sheet?
According to the last reported balance sheet, Green Cross Health had liabilities of NZ$112.8m due within 12 months, and liabilities of NZ$115.9m due beyond 12 months. Offsetting these obligations, it had cash of NZ$44.9m as well as receivables valued at NZ$34.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NZ$149.6m.
This deficit is considerable relative to its market capitalization of NZ$160.3m, so it does suggest shareholders should keep an eye on Green Cross Health's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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.
We note that Green Cross Health grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Green Cross 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Green Cross Health 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 three years, Green Cross Health actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing up
While Green Cross Health does have more liabilities than liquid assets, it also has net cash of NZ$3.75m. And it impressed us with free cash flow of NZ$67m, being 123% of its EBIT. So we are not troubled with Green Cross Health's debt use. 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. To that end, you should be aware of the 1 warning sign we've spotted with Green Cross Health .
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.
This article by Simply Wall St is general in nature. 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.
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