We Think AmerisourceBergen (NYSE:ABC) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that AmerisourceBergen Corporation (NYSE:ABC) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 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 AmerisourceBergen

How Much Debt Does AmerisourceBergen Carry?

As you can see below, AmerisourceBergen had US$4.93b of debt at March 2023, down from US$6.46b a year prior. However, it also had US$1.54b in cash, and so its net debt is US$3.39b.

A Look At AmerisourceBergen's Liabilities

We can see from the most recent balance sheet that AmerisourceBergen had liabilities of US$45.1b falling due within a year, and liabilities of US$13.2b due beyond that. On the other hand, it had cash of US$1.54b and US$19.5b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$37.2b.

When you consider that this deficiency exceeds the company's huge US$37.1b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 1.0 times its EBITDA. And its EBIT covers its interest expense a whopping 12.1 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, AmerisourceBergen's EBIT dived 11%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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'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. Over the last three years, AmerisourceBergen recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

AmerisourceBergen's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. Having said that, its EBIT growth rate somewhat sensitizes us to potential future risks to the balance sheet. We would also note that Healthcare industry companies like AmerisourceBergen commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about AmerisourceBergen's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for AmerisourceBergen that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.