David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ 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 can see that Q & M Dental Group (Singapore) Limited (SGX:QC7) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Q & M Dental Group (Singapore)
What Is Q & M Dental Group (Singapore)’s Net Debt?
As you can see below, Q & M Dental Group (Singapore) had S$85.7m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of S$35.2m, its net debt is less, at about S$50.5m.
How Strong Is Q & M Dental Group (Singapore)’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Q & M Dental Group (Singapore) had liabilities of S$29.3m due within 12 months and liabilities of S$132.6m due beyond that. Offsetting these obligations, it had cash of S$35.2m as well as receivables valued at S$24.1m due within 12 months. So its liabilities total S$102.6m more than the combination of its cash and short-term receivables.
This deficit isn’t so bad because Q & M Dental Group (Singapore) is worth S$408.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Q & M Dental Group (Singapore) has a low net debt to EBITDA ratio of only 1.2. And its EBIT easily covers its interest expense, being 13.2 times the size. So we’re pretty relaxed about its super-conservative use of debt. Also good is that Q & M Dental Group (Singapore) grew its EBIT at 12% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Q & M Dental Group (Singapore)’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Q & M Dental Group (Singapore) recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
The good news is that Q & M Dental Group (Singapore)’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! It’s also worth noting that Q & M Dental Group (Singapore) is in the Healthcare industry, which is often considered to be quite defensive. Zooming out, Q & M Dental Group (Singapore) seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. Be aware that Q & M Dental Group (Singapore) is showing 3 warning signs in our investment analysis , you should know about…
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
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