Is Narayana Hrudayalaya (NSE:NH) Using Too Much Debt?

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 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. As with many other companies Narayana Hrudayalaya Limited (NSE:NH) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Narayana Hrudayalaya

How Much Debt Does Narayana Hrudayalaya Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Narayana Hrudayalaya had ₹15.1b of debt, an increase on ₹9.61b, over one year. However, because it has a cash reserve of ₹11.9b, its net debt is less, at about ₹3.28b.

A Look At Narayana Hrudayalaya's Liabilities

We can see from the most recent balance sheet that Narayana Hrudayalaya had liabilities of ₹13.2b falling due within a year, and liabilities of ₹17.1b due beyond that. On the other hand, it had cash of ₹11.9b and ₹5.43b worth of receivables due within a year. So its liabilities total ₹13.1b more than the combination of its cash and short-term receivables.

Given Narayana Hrudayalaya has a market capitalization of ₹274.4b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Narayana Hrudayalaya has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

Narayana Hrudayalaya's net debt is only 0.29 times its EBITDA. And its EBIT covers its interest expense a whopping 10.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Narayana Hrudayalaya grew its EBIT by 5.0% in the last year, making that debt load look even more manageable. 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 Narayana Hrudayalaya's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Narayana Hrudayalaya's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Narayana Hrudayalaya's impressive net debt to EBITDA implies it has the upper hand on its debt. And that's just the beginning of the good news since its interest cover is also very heartening. It's also worth noting that Narayana Hrudayalaya is in the Healthcare industry, which is often considered to be quite defensive. When we consider the range of factors above, it looks like Narayana Hrudayalaya is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. Be aware that Narayana Hrudayalaya is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

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.