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One reason why Ramsay Health Care Limited is a risky bet

Credit: PerformanceHealth

Ramsay Health Care Limited’s (ASX: RHC) debt to equity ratio currently stands at 172%. That’s high by most investors’ standards and indicates that Ramsay’s balance sheet is highly leveraged in order to boost returns to its shareholders.

While interest rates are on a downward trajectory, such a high debt level could cause more risk averse investors to question whether Ramsay is a defensive stock. After all, many of its investors buy it for exactly that reason – especially while the outlook for the wider market is uncertain.

However, Ramsay’s high debt levels don’t concern me. That’s because it has a healthy cash balance of $315 million which means that Ramsay’s net debt to equity ratio is 154%. Further, its cash flow is strong. Net cash flow from operating activities was $746 million last year and this was sufficient to cover interest payments on the company’s debt 4.3 times.

Additionally, Ramsay’s cash flow is also strong enough to invest in its long term growth. For example, Ramsay has been able to allocate $731 million over the last two years to capital expenditure. As such, the company’s plan to have an increase in beds of 400 this year alongside 12 new theatres seems to be well funded.

Ramsay’s cash flow is also strong enough after debt repayments and investment in its long term growth prospects to pay a rapidly rising dividend. Free cash flow over the last two years has been $260 million (2015) and $316 million (2014), while dividends have been $197 million (2015) and $166 million (2014), which shows that they are not only affordable at their current level, but that there is also scope for them to rise and make Ramsay a more appealing income stock.

I’m also very comfortable with Ramsay’s debt levels because of its resilient business model. Private hospitals are not subject to the same booms and busts of the cycle as is the case for healthcare peers such as CSL Limited (ASX: CSL). And with Ramsay’s financial performance having a low correlation to the macroeconomic outlook, its cash flow is much more predictable than is the case for most of its ASX peers. This means that Ramsay can accommodate higher levels of leverage.

Of course a major benefit of higher debt is a boost to return on equity (ROE). Ramsay’s ROE in 2015 stood at 23%, while in 2014 it was 18%. Both of these figures would not be possible in Ramsay’s situation without the higher level of balance sheet risk.

Given its excellent cash flow, stable business model and low positive correlation with the wider economy, I feel very comfortable with Ramsay’s debt levels and its growth potential.

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Motley Fool contributor Robert Stephens has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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