Does Apollo Hospitals Enterprise (NSE:APOLLOHOSP) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Apollo Hospitals Enterprise Limited (NSE:APOLLOHOSP) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Apollo Hospitals Enterprise

What Is Apollo Hospitals Enterprise's Debt?

The image below, which you can click on for greater detail, shows that Apollo Hospitals Enterprise had debt of ₹32.8b at the end of March 2020, a reduction from ₹36.7b over a year. However, it also had ₹6.43b in cash, and so its net debt is ₹26.3b.

How Healthy Is Apollo Hospitals Enterprise's Balance Sheet?

We can see from the most recent balance sheet that Apollo Hospitals Enterprise had liabilities of ₹20.4b falling due within a year, and liabilities of ₹58.3b due beyond that. Offsetting these obligations, it had cash of ₹6.43b as well as receivables valued at ₹11.0b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹61.2b.

This deficit isn't so bad because Apollo Hospitals Enterprise is worth ₹235.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Apollo Hospitals Enterprise has a quite reasonable net debt to EBITDA multiple of 1.7, its interest cover seems weak, at 1.8. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. Importantly, Apollo Hospitals Enterprise grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Apollo Hospitals Enterprise can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Apollo Hospitals Enterprise recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On our analysis Apollo Hospitals Enterprise's EBIT growth rate should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. In particular, interest cover gives us cold feet. We would also note that Healthcare industry companies like Apollo Hospitals Enterprise commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Apollo Hospitals Enterprise is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Apollo Hospitals Enterprise (1 is a bit unpleasant!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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