Max Healthcare Institute (NSE:MAXHEALTH) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Max Healthcare Institute Limited (NSE:MAXHEALTH) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Max Healthcare Institute

What Is Max Healthcare Institute's Debt?

The image below, which you can click on for greater detail, shows that Max Healthcare Institute had debt of ₹7.27b at the end of March 2022, a reduction from ₹9.20b over a year. However, it does have ₹4.99b in cash offsetting this, leading to net debt of about ₹2.27b.

A Look At Max Healthcare Institute's Liabilities

The latest balance sheet data shows that Max Healthcare Institute had liabilities of ₹7.57b due within a year, and liabilities of ₹21.5b falling due after that. Offsetting this, it had ₹4.99b in cash and ₹4.18b in receivables that were due within 12 months. So its liabilities total ₹19.9b more than the combination of its cash and short-term receivables.

Given Max Healthcare Institute has a market capitalization of ₹362.1b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, Max Healthcare Institute has a very light debt load indeed.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Max Healthcare Institute has a low net debt to EBITDA ratio of only 0.25. And its EBIT easily covers its interest expense, being 28.0 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 197% 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'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. In the last three years, Max Healthcare Institute created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Happily, Max Healthcare Institute's impressive interest cover implies it has the upper hand on its debt. 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. We'd be motivated to research the stock further if we found out that Max Healthcare Institute insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.