These 4 Measures Indicate That MERCK Kommanditgesellschaft auf Aktien (ETR:MRK) Is Using Debt Reasonably Well

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. Importantly, MERCK Kommanditgesellschaft auf Aktien (ETR:MRK) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out 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 €13.0b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had €1.63b in cash, and so its net debt is €11.4b.

A Look At MERCK Kommanditgesellschaft auf Aktien's Liabilities

Zooming in on the latest balance sheet data, we can see that MERCK Kommanditgesellschaft auf Aktien had liabilities of €9.71b due within 12 months and liabilities of €15.5b due beyond that. Offsetting these obligations, it had cash of €1.63b as well as receivables valued at €4.10b due within 12 months. So it has liabilities totalling €19.5b more than its cash and near-term receivables, combined.

MERCK Kommanditgesellschaft auf Aktien has a very large market capitalization of €58.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

MERCK Kommanditgesellschaft auf Aktien's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its strong interest cover of 10.1 times, makes us even more comfortable. Importantly, MERCK Kommanditgesellschaft auf Aktien grew its EBIT by 52% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MERCK Kommanditgesellschaft auf Aktien'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, MERCK Kommanditgesellschaft auf Aktien recorded free cash flow worth 63% 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 EBIT growth rate implies it has the upper hand on its debt. And the good news does not stop there, as its interest cover also supports that impression! When we consider the range of factors above, it looks like MERCK Kommanditgesellschaft auf Aktien is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with MERCK Kommanditgesellschaft auf Aktien , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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