Here's Why Max Healthcare Institute (NSE:MAXHEALTH) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Max Healthcare Institute Limited (NSE:MAXHEALTH) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Max Healthcare Institute

What Is Max Healthcare Institute's Net Debt?

The image below, which you can click on for greater detail, shows that Max Healthcare Institute had debt of ₹10.0b at the end of September 2021, a reduction from ₹17.8b over a year. However, it also had ₹7.29b in cash, and so its net debt is ₹2.74b.

A Look At Max Healthcare Institute's Liabilities

The latest balance sheet data shows that Max Healthcare Institute had liabilities of ₹7.55b due within a year, and liabilities of ₹20.7b falling due after that. Offsetting these obligations, it had cash of ₹7.29b as well as receivables valued at ₹4.54b due within 12 months. So it has liabilities totalling ₹16.4b more than its cash and near-term receivables, combined.

Since publicly traded Max Healthcare Institute shares are worth a total of ₹342.9b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Carrying virtually no net debt, Max Healthcare Institute has a very light debt load indeed.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Max Healthcare Institute's net debt is only 0.29 times its EBITDA. And its EBIT easily covers its interest expense, being 17.2 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Max Healthcare Institute grew its EBIT by 194% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Max Healthcare Institute 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Max Healthcare Institute recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Max Healthcare Institute's demonstrated ability to cover its interest expense with 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 Max Healthcare Institute is in the Healthcare industry, which is often considered to be quite defensive. Looking at the bigger picture, we think Max Healthcare Institute's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. For example, we've discovered 3 warning signs for Max Healthcare Institute that you should be aware of before investing here.

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.

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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.