The healthcare industry remains one of the largest and fastest growing industries in the world…
Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Fresenius Medical Care AG & Co. KGaA (ETR:FME) is in debt. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Fresenius Medical Care KGaA
What is Fresenius Medical Care KGaA’s net debt?
As you can see below, at the end of March 2022, Fresenius Medical Care KGaA had a debt of 8.63 billion euros, compared to 8.24 billion euros a year ago. Click on the image for more details. However, he has €1.17 billion in cash to offset this, resulting in a net debt of around €7.45 billion.
How healthy is Fresenius Medical Care KGaA’s balance sheet?
We can see from the most recent balance sheet that Fresenius Medical Care KGaA had liabilities of €6.38 billion due in one year, and liabilities of €13.8 billion due beyond. On the other hand, it had 1.17 billion euros in cash and 3.89 billion euros in receivables at less than one year. Thus, its liabilities total 15.1 billion euros more than the combination of its cash and short-term receivables.
This deficit is considerable compared to its very large market capitalization of 15.9 billion euros, so it suggests that shareholders monitor the use of debt by Fresenius Medical Care KGaA. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Fresenius Medical Care KGaA’s debt represents 2.9 times its EBITDA and its EBIT covers its interest charges 6.3 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. Importantly, Fresenius Medical Care KGaA’s EBIT has fallen by 25% over the last twelve months. If this decline continues, it will be more difficult to repay debts than to sell foie gras at a vegan convention. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Fresenius Medical Care KGaA’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Fresenius Medical Care KGaA has actually generated more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
Fresenius Medical Care KGaA’s EBIT growth rate and the level of total liabilities are undoubtedly weighing on it, in our view. But the good news is that it seems to be able to easily convert EBIT to free cash flow. It should also be noted that companies in the healthcare sector such as Fresenius Medical Care KGaA generally use debt without problems. Considering the above factors, we believe Fresenius Medical Care KGaA’s debt poses certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Example: we have identified 1 warning sign for Fresenius Medical Care KGaA you should be aware.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.