We Think MERCK Kommanditgesellschaft auf Aktien (ETR:MRK) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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, 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for MERCK Kommanditgesellschaft auf Aktien

What Is MERCK Kommanditgesellschaft auf Aktien's Net Debt?

As you can see below, MERCK Kommanditgesellschaft auf Aktien had €10.6b of debt, at September 2022, which is about the same as the year before. You can click the chart for greater detail. However, it also had €1.95b in cash, and so its net debt is €8.61b.

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 €9.41b falling due within a year, and liabilities of €13.2b due beyond that. Offsetting this, it had €1.95b in cash and €4.80b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €15.8b.

While this might seem like a lot, it is not so bad since MERCK Kommanditgesellschaft auf Aktien has a huge market capitalization of €78.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). 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 1.3 times its EBITDA. And its EBIT covers its interest expense a whopping 39.4 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that MERCK Kommanditgesellschaft auf Aktien has boosted its EBIT by 36%, thus reducing the spectre of future debt repayments. 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 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, MERCK Kommanditgesellschaft auf Aktien produced sturdy free cash flow equating to 64% 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! Looking at the bigger picture, we think MERCK Kommanditgesellschaft auf Aktien's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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 you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.