We Think Roche Holding (VTX:ROG) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Roche Holding AG (VTX:ROG) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Roche Holding

What Is Roche Holding's Debt?

The image below, which you can click on for greater detail, shows that Roche Holding had debt of CHF25.4b at the end of June 2023, a reduction from CHF27.8b over a year. On the flip side, it has CHF7.51b in cash leading to net debt of about CHF17.9b.

How Healthy Is Roche Holding's Balance Sheet?

We can see from the most recent balance sheet that Roche Holding had liabilities of CHF26.2b falling due within a year, and liabilities of CHF27.8b due beyond that. On the other hand, it had cash of CHF7.51b and CHF11.4b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF35.2b.

Of course, Roche Holding has a titanic market capitalization of CHF201.3b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Roche Holding has a low net debt to EBITDA ratio of only 0.78. And its EBIT covers its interest expense a whopping 30.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Roche Holding saw its EBIT drop by 10.0% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Roche Holding'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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Roche Holding recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Roche Holding's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Roche Holding can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Roche Holding that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.