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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 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?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See 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 €9.94b of debt, at December 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 €2.10b, its net debt is less, at about €7.84b.

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

We can see from the most recent balance sheet that MERCK Kommanditgesellschaft auf Aktien had liabilities of €9.51b falling due within a year, and liabilities of €13.0b due beyond that. Offsetting this, it had €2.10b in cash and €5.03b in receivables that were due within 12 months. So its liabilities total €15.4b more than the combination of its cash and short-term receivables.

MERCK Kommanditgesellschaft auf Aktien has a very large market capitalization of €73.3b, 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

MERCK Kommanditgesellschaft auf Aktien's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 40.7 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that MERCK Kommanditgesellschaft auf Aktien grew its EBIT by 16% last year, making its debt load easier to handle. 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 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 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that MERCK Kommanditgesellschaft auf Aktien's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! 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.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.