These 4 Measures Indicate That Abbott Laboratories (NYSE:ABT) Is Using Debt Reasonably Well

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.' 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 Abbott Laboratories (NYSE:ABT) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Abbott Laboratories

How Much Debt Does Abbott Laboratories Carry?

As you can see below, Abbott Laboratories had US$14.7b of debt at March 2024, down from US$17.0b a year prior. However, it does have US$6.65b in cash offsetting this, leading to net debt of about US$8.05b.

A Look At Abbott Laboratories' Liabilities

The latest balance sheet data shows that Abbott Laboratories had liabilities of US$14.0b due within a year, and liabilities of US$19.4b falling due after that. Offsetting these obligations, it had cash of US$6.65b as well as receivables valued at US$6.61b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$20.2b.

Given Abbott Laboratories has a humongous market capitalization of US$180.8b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Abbott Laboratories has a low net debt to EBITDA ratio of only 0.78. And its EBIT easily covers its interest expense, being 27.3 times the size. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Abbott Laboratories saw its EBIT decline by 7.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Abbott Laboratories 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 always check how much of that EBIT is translated into free cash flow. During the last three years, Abbott Laboratories produced sturdy free cash flow equating to 80% 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 Abbott Laboratories's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. We would also note that Medical Equipment industry companies like Abbott Laboratories commonly do use debt without problems. Zooming out, Abbott Laboratories seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Abbott Laboratories you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

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