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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Siemens Healthineers AG (ETR:SHL) does use debt in its business. But is this debt a concern to shareholders?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Siemens Healthineers's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2021 Siemens Healthineers had debt of €14.9b, up from €6.12b in one year. However, it does have €1.47b in cash offsetting this, leading to net debt of about €13.4b.
How Strong Is Siemens Healthineers' Balance Sheet?
The latest balance sheet data shows that Siemens Healthineers had liabilities of €9.88b due within a year, and liabilities of €16.3b falling due after that. Offsetting this, it had €1.47b in cash and €6.08b in receivables that were due within 12 months. So it has liabilities totalling €18.7b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Siemens Healthineers has a huge market capitalization of €65.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Siemens Healthineers's net debt is 4.0 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 55.0 is very high, suggesting that the interest expense on the debt is currently quite low. One way Siemens Healthineers could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 15%, as it did over the last year. 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 Siemens Healthineers 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Siemens Healthineers produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Happily, Siemens Healthineers's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its net debt to EBITDA. We would also note that Medical Equipment industry companies like Siemens Healthineers commonly do use debt without problems. Taking all this data into account, it seems to us that Siemens Healthineers takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Siemens Healthineers .
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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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Siemens Healthineers AG, through its subsidiaries, develops, manufactures, and sells a range of diagnostic and therapeutic products and services to healthcare providers worldwide.
Proven track record with moderate growth potential.