We Think Abbott Laboratories (NYSE:ABT) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Abbott Laboratories

What Is Abbott Laboratories's Debt?

As you can see below, Abbott Laboratories had US$17.0b of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$8.16b, its net debt is less, at about US$8.83b.

How Strong Is Abbott Laboratories' Balance Sheet?

According to the last reported balance sheet, Abbott Laboratories had liabilities of US$14.4b due within 12 months, and liabilities of US$21.6b due beyond 12 months. Offsetting these obligations, it had cash of US$8.16b as well as receivables valued at US$6.17b due within 12 months. So it has liabilities totalling US$21.6b more than its cash and near-term receivables, combined.

Since publicly traded Abbott Laboratories shares are worth a very impressive total of US$182.8b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Abbott Laboratories's net debt is only 0.89 times its EBITDA. And its EBIT easily covers its interest expense, being 25.2 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Abbott Laboratories's saving grace is its low debt levels, because its EBIT has tanked 37% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Abbott Laboratories'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Abbott Laboratories generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Abbott Laboratories's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its EBIT growth rate. We would also note that Medical Equipment industry companies like Abbott Laboratories commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that Abbott Laboratories can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with Abbott Laboratories .

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.