Warren Buffett said: “Volatility is far from synonymous with risk. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Instituto de Diagnostico SA (SNSE:INDISA) has debt on its balance sheet. But does this debt worry shareholders?
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Instituto de Diagnóstico
What is the net debt of the Instituto de Diagnóstico?
The image below, which you can click on for more details, shows that as of December 2021, the Instituto de Diagnóstico had a debt of CL$76.3 billion, compared to CL$55.8 billion in a year. However, he has CL$9.75 billion in cash to offset this, resulting in a net debt of approximately CL$66.6 billion.
How strong is the balance sheet of the Instituto de Diagnóstico?
The latest balance sheet data shows that the Instituto de Diagnóstico had liabilities of CL$95.9 billion due within one year, and liabilities of CL$39.8 billion falling due thereafter. As compensation for these obligations, it had cash of CL$9.75 billion as well as receivables valued at CL$72.1 billion and due within 12 months. Thus, its liabilities total CL$53.9 billion more than the combination of its cash and short-term receivables.
This shortfall is not that serious as the Instituto de Diagnóstico is worth CL$177.0 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With a debt to EBITDA ratio of 2.4, the Instituto de Diagnóstico uses debt wisely but responsibly. And the attractive interest cover (EBIT of 8.8 times interest expense) certainly makes do not do everything to dispel this impression. Notably, the Instituto de Diagnóstico’s EBIT launched higher than Elon Musk, gaining a whopping 312% over last year. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the profits of the Instituto de Diagnóstico that will influence the balance sheet in the future. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, the Instituto de Diagnóstico has had substantial negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
The conversion of EBIT to free cash flow by the Instituto de Diagnóstico was a real negative in this analysis, even though the other factors we considered were considerably better. There is no doubt that its ability to grow its EBIT is quite meteoric. We also note that companies in the health sector like the Instituto de Diagnóstico generally use debt without problems. Looking at all this data, we feel a bit cautious about the Instituto de Diagnóstico’s debt levels. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 4 warning signs with the Instituto de Diagnóstico (at least 3 that are significant), and understanding them should be part of your investment process.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.