Here's Why Fortis Healthcare (NSE:FORTIS) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Fortis Healthcare Limited (NSE:FORTIS) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Fortis Healthcare

How Much Debt Does Fortis Healthcare Carry?

You can click the graphic below for the historical numbers, but it shows that Fortis Healthcare had ₹12.4b of debt in September 2021, down from ₹13.2b, one year before. However, it also had ₹3.58b in cash, and so its net debt is ₹8.80b.

How Healthy Is Fortis Healthcare's Balance Sheet?

According to the last reported balance sheet, Fortis Healthcare had liabilities of ₹14.3b due within 12 months, and liabilities of ₹35.6b due beyond 12 months. Offsetting this, it had ₹3.58b in cash and ₹4.60b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹41.7b.

Since publicly traded Fortis Healthcare shares are worth a total of ₹216.4b, 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.

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.

While Fortis Healthcare's low debt to EBITDA ratio of 0.99 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 7.0 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. It was also good to see that despite losing money on the EBIT line last year, Fortis Healthcare turned things around in the last 12 months, delivering and EBIT of ₹6.6b. 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 Fortis Healthcare's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Fortis Healthcare actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Fortis Healthcare's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. We would also note that Healthcare industry companies like Fortis Healthcare commonly do use debt without problems. When we consider the range of factors above, it looks like Fortis Healthcare is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. We've identified 1 warning sign with Fortis Healthcare , and understanding them should be part of your investment process.

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.

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.