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. Importantly, AmerisourceBergen Corporation (NYSE:ABC) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does AmerisourceBergen Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2021 AmerisourceBergen had US$6.92b of debt, an increase on US$4.14b, over one year. However, it does have US$2.55b in cash offsetting this, leading to net debt of about US$4.37b.
A Look At AmerisourceBergen's Liabilities
According to the last reported balance sheet, AmerisourceBergen had liabilities of US$39.6b due within 12 months, and liabilities of US$15.9b due beyond 12 months. Offsetting this, it had US$2.55b in cash and US$17.9b in receivables that were due within 12 months. So its liabilities total US$35.0b more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's massive market capitalization of US$25.3b, we think shareholders really should watch AmerisourceBergen's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
AmerisourceBergen's net debt is only 1.4 times its EBITDA. And its EBIT covers its interest expense a whopping 17.4 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, AmerisourceBergen grew its EBIT by 46% 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 ultimately the future profitability of the business will decide if AmerisourceBergen 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, while the tax-man may adore accounting profits, lenders only accept 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, AmerisourceBergen generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
The good news is that AmerisourceBergen's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its level of total liabilities. It's also worth noting that AmerisourceBergen is in the Healthcare industry, which is often considered to be quite defensive. All these things considered, it appears that AmerisourceBergen can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. Be aware that AmerisourceBergen is showing 2 warning signs in our investment analysis , you should know about...
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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