We Think Siemens Healthineers (ETR:SHL) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Siemens Healthineers AG (ETR:SHL) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Siemens Healthineers

What Is Siemens Healthineers's Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Siemens Healthineers had debt of €14.1b, up from €6.08b in one year. However, it does have €660.0m in cash offsetting this, leading to net debt of about €13.5b.

How Strong Is Siemens Healthineers' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Siemens Healthineers had liabilities of €8.36b due within 12 months and liabilities of €13.7b due beyond that. Offsetting this, it had €660.0m in cash and €18.2b in receivables that were due within 12 months. So it has liabilities totalling €3.11b more than its cash and near-term receivables, combined.

Of course, Siemens Healthineers has a titanic market capitalization of €51.7b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Siemens Healthineers has a debt to EBITDA ratio of 4.6, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 50.3 is very high, suggesting that the interest expense on the debt is currently quite low. Notably Siemens Healthineers's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Siemens Healthineers 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Siemens Healthineers recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Siemens Healthineers's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its net debt to EBITDA has the opposite effect. We would also note that Medical Equipment industry companies like Siemens Healthineers commonly do use debt without problems. When we consider the range of factors above, it looks like Siemens Healthineers is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Siemens Healthineers (at least 1 which is significant) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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