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

Warren Buffett famously said, '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 MERCK Kommanditgesellschaft auf Aktien (ETR:MRK) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

Check out our latest analysis for MERCK Kommanditgesellschaft auf Aktien

What Is MERCK Kommanditgesellschaft auf Aktien's Debt?

As you can see below, MERCK Kommanditgesellschaft auf Aktien had €11.7b of debt at December 2020, down from €12.6b a year prior. However, it does have €1.37b in cash offsetting this, leading to net debt of about €10.3b.

How Strong Is MERCK Kommanditgesellschaft auf Aktien's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that MERCK Kommanditgesellschaft auf Aktien had liabilities of €9.23b due within 12 months and liabilities of €15.5b due beyond that. Offsetting these obligations, it had cash of €1.37b as well as receivables valued at €4.28b due within 12 months. So it has liabilities totalling €19.1b more than its cash and near-term receivables, combined.

MERCK Kommanditgesellschaft auf Aktien has a very large market capitalization of €63.3b, 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.

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). 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 2.2 suggests only moderate use of debt. And its strong interest cover of 10.7 times, makes us even more comfortable. Also relevant is that MERCK Kommanditgesellschaft auf Aktien has grown its EBIT by a very respectable 20% in the last year, thus enhancing its ability to pay down 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, MERCK Kommanditgesellschaft auf Aktien produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, MERCK Kommanditgesellschaft auf Aktien's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate 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. 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. Case in point: We've spotted 1 warning sign for MERCK Kommanditgesellschaft auf Aktien 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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