Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that Siemens Healthineers AG (ETR:SHL) uses debt in its operations. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. 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. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Siemens Healthineers
What is Siemens Healthineers net debt?
You can click on the graph below for historical figures, but it shows that in September 2021, Siemens Healthineers had 13.7 billion euros in debt, an increase from 5.05 billion euros, on a year. However, since it has a cash reserve of 1.40 billion euros, its net debt is lower, at around 12.3 billion euros.
How healthy is Siemens Healthineers balance sheet?
Zooming in on the latest balance sheet data, we can see that Siemens Healthineers had liabilities of €10.1 billion due within 12 months and liabilities of €15.8 billion due beyond. On the other hand, it had 1.40 billion euros in cash and 6.06 billion euros in receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by €18.4 billion.
Siemens Healthineers has a very large market capitalization of 66.8 billion euros, so it could very likely raise funds to improve its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Siemens Healthineers has a debt to EBITDA ratio of 3.7, which signals significant debt, but is still fairly reasonable for most types of businesses. However, its interest coverage of 51.1 is very high, suggesting that debt interest charges are currently quite low. Above all, Siemens Healthineers has increased its EBIT by 32% over the last twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Siemens Healthineers can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Siemens Healthineers has produced strong free cash flow equivalent to 69% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Siemens Healthineers interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But truth be told, we think its net debt to EBITDA somewhat undermines that impression. We also note that companies in the medical equipment industry like Siemens Healthineers routinely use debt without issue. Zooming out, Siemens Healthineers appears to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Siemens Healthineers you should know.
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% free, at 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.