Is Ramsay Health Care (ASX:RHC) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Ramsay Health Care Limited (ASX:RHC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Ramsay Health Care Carry?

The chart below, which you can click on for greater detail, shows that Ramsay Health Care had AU$5.27b in debt in December 2024; about the same as the year before. However, because it has a cash reserve of AU$342.7m, its net debt is less, at about AU$4.93b.

How Strong Is Ramsay Health Care's Balance Sheet?

According to the last reported balance sheet, Ramsay Health Care had liabilities of AU$3.72b due within 12 months, and liabilities of AU$11.5b due beyond 12 months. On the other hand, it had cash of AU$342.7m and AU$2.39b worth of receivables due within a year. So its liabilities total AU$12.5b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the AU$7.87b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Ramsay Health Care would likely require a major re-capitalisation if it had to pay its creditors today.

Check out our latest analysis for Ramsay Health Care

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 we wouldn't worry about Ramsay Health Care's net debt to EBITDA ratio of 3.2, we think its super-low interest cover of 1.6 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. On a slightly more positive note, Ramsay Health Care 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 ultimately the future profitability of the business will decide if Ramsay Health Care can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Ramsay Health Care produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

To be frank both Ramsay Health Care's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. We should also note that Healthcare industry companies like Ramsay Health Care commonly do use debt without problems. Overall, we think it's fair to say that Ramsay Health Care has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Ramsay Health Care (of which 1 is concerning!) you should know about.

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. 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.