Is Sakar Healthcare (NSE:SAKAR) A Risky Investment?

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.' 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. We can see that Sakar Healthcare Limited (NSE:SAKAR) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sakar Healthcare

What Is Sakar Healthcare's Debt?

The image below, which you can click on for greater detail, shows that Sakar Healthcare had debt of ₹769.8m at the end of September 2023, a reduction from ₹1.07b over a year. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Sakar Healthcare's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sakar Healthcare had liabilities of ₹467.8m due within 12 months and liabilities of ₹736.3m due beyond that. On the other hand, it had cash of ₹3.16m and ₹201.5m worth of receivables due within a year. So its liabilities total ₹999.5m more than the combination of its cash and short-term receivables.

Since publicly traded Sakar Healthcare shares are worth a total of ₹7.64b, 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). 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).

Sakar Healthcare's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 2.8 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Unfortunately, Sakar Healthcare saw its EBIT slide 2.6% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sakar Healthcare's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Sakar Healthcare burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We'd go so far as to say Sakar Healthcare's conversion of EBIT to free cash flow was disappointing. Having said that, its ability to handle its total liabilities isn't such a worry. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Sakar Healthcare stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Sakar Healthcare (of which 1 doesn't sit too well with us!) you should know about.

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.