Here's Why AstraZeneca (LON:AZN) Can Manage Its Debt Responsibly

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 can see that AstraZeneca PLC (LON:AZN) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for AstraZeneca

What Is AstraZeneca's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 AstraZeneca had debt of US$30.2b, up from US$28.6b in one year. However, because it has a cash reserve of US$4.93b, its net debt is less, at about US$25.3b.

How Healthy Is AstraZeneca's Balance Sheet?

The latest balance sheet data shows that AstraZeneca had liabilities of US$25.9b due within a year, and liabilities of US$38.2b falling due after that. On the other hand, it had cash of US$4.93b and US$13.5b worth of receivables due within a year. So its liabilities total US$45.6b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because AstraZeneca is worth a massive US$202.8b, and thus could probably raise enough capital to shore up 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).

AstraZeneca's net debt is only 1.4 times its EBITDA. And its EBIT covers its interest expense a whopping 15.3 times over. So we're pretty relaxed about its super-conservative use of debt. Also good is that AstraZeneca grew its EBIT at 14% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if AstraZeneca 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, AstraZeneca 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

AstraZeneca's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! When we consider the range of factors above, it looks like AstraZeneca is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - AstraZeneca has 3 warning signs we think you should be aware of.

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.