Lonza Group (VTX:LONN) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Lonza Group AG (VTX:LONN) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Debt?

As you can see below, Lonza Group had CHF2.40b of debt at June 2022, down from CHF3.65b a year prior. However, it does have CHF2.44b in cash offsetting this, leading to net cash of CHF32.0m.

A Look At Lonza Group's Liabilities

According to the last reported balance sheet, Lonza Group had liabilities of CHF2.63b due within 12 months, and liabilities of CHF4.03b due beyond 12 months. Offsetting these obligations, it had cash of CHF2.44b as well as receivables valued at CHF1.16b due within 12 months. So it has liabilities totalling CHF3.06b more than its cash and near-term receivables, combined.

Given Lonza Group has a humongous market capitalization of CHF33.7b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Lonza Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Lonza Group's EBIT dived 12%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Lonza Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Lonza Group recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

We could understand if investors are concerned about Lonza Group's liabilities, but we can be reassured by the fact it has has net cash of CHF32.0m. So we don't have any problem with Lonza Group's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Lonza Group that you should be aware of before investing here.

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.