Does Lonza Group (VTX:LONN) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Lonza Group Ltd (VTX:LONN) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Lonza Group

What Is Lonza Group's Net Debt?

The image below, which you can click on for greater detail, shows that Lonza Group had debt of CHF3.65b at the end of June 2021, a reduction from CHF3.82b over a year. On the flip side, it has CHF501.0m in cash leading to net debt of about CHF3.15b.

A Look At Lonza Group's Liabilities

According to the last reported balance sheet, Lonza Group had liabilities of CHF3.11b due within 12 months, and liabilities of CHF4.71b due beyond 12 months. Offsetting these obligations, it had cash of CHF501.0m as well as receivables valued at CHF834.0m due within 12 months. So its liabilities total CHF6.49b more than the combination of its cash and short-term receivables.

Of course, Lonza Group has a titanic market capitalization of CHF53.4b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Lonza Group's moderate net debt to EBITDA ratio ( being 2.1), indicates prudence when it comes to debt. And its strong interest cover of 13.7 times, makes us even more comfortable. If Lonza Group can keep growing EBIT at last year's rate of 10% over the last year, then it will find its debt load easier to manage. 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 Lonza Group'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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Lonza Group's free cash flow amounted to 21% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On our analysis Lonza Group's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. Considering this range of data points, we think Lonza Group is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Lonza Group .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.