Universal Health Services (NYSE:UHS) Takes On Some Risk With Its Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Universal Health Services, Inc. (NYSE:UHS) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Universal Health Services

What Is Universal Health Services's Debt?

The chart below, which you can click on for greater detail, shows that Universal Health Services had US$4.72b in debt in June 2023; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Universal Health Services' Balance Sheet?

We can see from the most recent balance sheet that Universal Health Services had liabilities of US$2.04b falling due within a year, and liabilities of US$5.56b due beyond that. Offsetting these obligations, it had cash of US$79.5m as well as receivables valued at US$2.10b due within 12 months. So it has liabilities totalling US$5.42b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$8.62b, so it does suggest shareholders should keep an eye on Universal Health Services' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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

Universal Health Services's debt is 2.7 times its EBITDA, and its EBIT cover its interest expense 6.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Universal Health Services grew its EBIT by 2.5% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Universal Health Services'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Universal Health Services recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Universal Health Services's level of total liabilities and its conversion of EBIT to free cash flow were discouraging. At least its interest cover gives us reason to be optimistic. It's also worth noting that Universal Health Services is in the Healthcare industry, which is often considered to be quite defensive. We think that Universal Health Services's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 1 warning sign for Universal Health Services that you should be aware of before investing here.

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.