Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Fortis Health Limited (NSE: FORTIS) uses debt. But does this debt worry shareholders?
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Fortis Healthcare
What is Fortis Healthcare’s net debt?
The image below, which you can click on for more details, shows that Fortis Healthcare had debt of ₹9.66 billion at the end of March 2022, a reduction from ₹12.7 billion year on year. However, he has ₹4.13 billion in cash to offset this, resulting in a net debt of around ₹5.53 billion.
How strong is Fortis Healthcare’s balance sheet?
We can see from the most recent balance sheet that Fortis Healthcare had liabilities of ₹12.7 billion due within a year, and liabilities of ₹36.1 billion due beyond. As compensation for these obligations, it had cash of ₹4.13 billion as well as receivables valued at ₹5.14 billion due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by ₹39.5 billion.
This shortfall is not that bad as Fortis Healthcare is worth ₹181.6 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
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). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
While Fortis Healthcare’s low debt to EBITDA ratio of 0.52 suggests only modest debt utilization, the fact that EBIT only covered interest expense 5.2 times a year last makes us think. But the interest payments are certainly enough to make us think about the affordability of its debt. Notably, Fortis Healthcare’s EBIT launched higher than Elon Musk, gaining 549% from a year ago. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Fortis Healthcare can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Fortis Healthcare has recorded free cash flow of 78% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Fortis Healthcare’s EBIT growth rate suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And the good news doesn’t stop there, since its conversion of EBIT into free cash flow also confirms this impression! We are also noticing that healthcare companies like Fortis Healthcare routinely use debt without issue. Overall, we don’t think Fortis Healthcare is taking bad risks, as its leverage looks modest. So we are not worried about using a little leverage on the balance sheet. 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. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Fortis Healthcare you should know.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.