Does MERCK Kommanditgesellschaft auf Aktien (ETR:MRK) 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 note that MERCK Kommanditgesellschaft auf Aktien (ETR:MRK) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for MERCK Kommanditgesellschaft auf Aktien

How Much Debt Does MERCK Kommanditgesellschaft auf Aktien Carry?

As you can see below, MERCK Kommanditgesellschaft auf Aktien had €11.3b of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of €1.71b, its net debt is less, at about €9.63b.

A Look At MERCK Kommanditgesellschaft auf Aktien's Liabilities

The latest balance sheet data shows that MERCK Kommanditgesellschaft auf Aktien had liabilities of €9.72b due within a year, and liabilities of €13.0b falling due after that. Offsetting this, it had €1.71b in cash and €4.87b in receivables that were due within 12 months. So it has liabilities totalling €16.1b more than its cash and near-term receivables, combined.

MERCK Kommanditgesellschaft auf Aktien has a very large market capitalization of €79.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

MERCK Kommanditgesellschaft auf Aktien's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its strong interest cover of 32.7 times, makes us even more comfortable. And we also note warmly that MERCK Kommanditgesellschaft auf Aktien grew its EBIT by 10% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if MERCK Kommanditgesellschaft auf Aktien can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, MERCK Kommanditgesellschaft auf Aktien recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, MERCK Kommanditgesellschaft auf Aktien's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Taking all this data into account, it seems to us that MERCK Kommanditgesellschaft auf Aktien takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. Over time, share prices tend to follow earnings per share, so if you're interested in MERCK Kommanditgesellschaft auf Aktien, you may well want to click here to check an interactive graph of its earnings per share history.

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.