Is Rainbow Children's Medicare (NSE:RAINBOW) A Risky Investment?

Warren Buffett famously said, '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 Rainbow Children's Medicare Limited (NSE:RAINBOW) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Rainbow Children's Medicare

How Much Debt Does Rainbow Children's Medicare Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Rainbow Children's Medicare had ₹7.65b of debt, an increase on ₹5.70b, over one year. On the flip side, it has ₹5.02b in cash leading to net debt of about ₹2.63b.

How Healthy Is Rainbow Children's Medicare's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Rainbow Children's Medicare had liabilities of ₹1.49b due within 12 months and liabilities of ₹7.56b due beyond that. Offsetting these obligations, it had cash of ₹5.02b as well as receivables valued at ₹809.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹3.22b.

Since publicly traded Rainbow Children's Medicare shares are worth a total of ₹138.9b, 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt sitting at just 0.67 times EBITDA, Rainbow Children's Medicare is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 9.2 times the interest expense over the last year. Rainbow Children's Medicare's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 Rainbow Children's Medicare'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Rainbow Children's Medicare recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Rainbow Children's Medicare's impressive net debt to EBITDA implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. We would also note that Healthcare industry companies like Rainbow Children's Medicare commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that Rainbow Children's Medicare can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Rainbow Children's Medicare you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.