These 4 Measures Indicate That RHÖN-KLINIKUM (ETR:RHK) Is Using Debt Reasonably Well

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. As with many other companies RHÖN-KLINIKUM Aktiengesellschaft (ETR:RHK) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for RHÖN-KLINIKUM

What Is RHÖN-KLINIKUM's Net Debt?

The chart below, which you can click on for greater detail, shows that RHÖN-KLINIKUM had €151.1m in debt in June 2022; about the same as the year before. However, because it has a cash reserve of €99.4m, its net debt is less, at about €51.7m.

How Healthy Is RHÖN-KLINIKUM's Balance Sheet?

According to the last reported balance sheet, RHÖN-KLINIKUM had liabilities of €284.9m due within 12 months, and liabilities of €168.9m due beyond 12 months. Offsetting these obligations, it had cash of €99.4m as well as receivables valued at €237.0m due within 12 months. So its liabilities total €117.5m more than the combination of its cash and short-term receivables.

Since publicly traded RHÖN-KLINIKUM shares are worth a total of €870.2m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 0.53 times EBITDA, RHÖN-KLINIKUM is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 8.2 times the interest expense over the last year. On top of that, RHÖN-KLINIKUM grew its EBIT by 87% 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 it is future earnings, more than anything, that will determine RHÖN-KLINIKUM's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, RHÖN-KLINIKUM's free cash flow amounted to 21% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that RHÖN-KLINIKUM's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. It's also worth noting that RHÖN-KLINIKUM is in the Healthcare industry, which is often considered to be quite defensive. When we consider the range of factors above, it looks like RHÖN-KLINIKUM is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. Over time, share prices tend to follow earnings per share, so if you're interested in RHÖN-KLINIKUM, you may well want to click here to check an interactive graph of its earnings per share history.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.