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Aster DM Healthcare (NSE:ASTERDM) Takes On Some Risk With Its Use Of Debt

Simply Wall St

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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Aster DM Healthcare Limited (NSE:ASTERDM) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Aster DM Healthcare

What Is Aster DM Healthcare's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2019 Aster DM Healthcare had debt of ₹26.8b, up from ₹23.6b in one year. However, it also had ₹2.50b in cash, and so its net debt is ₹24.3b.

NSEI:ASTERDM Historical Debt, October 2nd 2019
NSEI:ASTERDM Historical Debt, October 2nd 2019

A Look At Aster DM Healthcare's Liabilities

According to the last reported balance sheet, Aster DM Healthcare had liabilities of ₹26.7b due within 12 months, and liabilities of ₹25.9b due beyond 12 months. On the other hand, it had cash of ₹2.50b and ₹23.1b worth of receivables due within a year. So it has liabilities totalling ₹26.9b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Aster DM Healthcare has a market capitalization of ₹59.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Aster DM Healthcare's debt is 2.9 times its EBITDA, and its EBIT cover its interest expense 3.1 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Aster DM Healthcare grew its EBIT a smooth 47% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Aster DM Healthcare can strengthen its balance sheet over time. 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. During the last three years, Aster DM Healthcare burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Aster DM Healthcare's conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. It's also worth noting that Aster DM Healthcare is in the Healthcare industry, which is often considered to be quite defensive. We think that Aster DM Healthcare'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. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.