Stock Analysis

Here's Why Baxter International (NYSE:BAX) Can Manage Its Debt Responsibly

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NYSE:BAX
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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Baxter International Inc. (NYSE:BAX) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Baxter International

What Is Baxter International's Debt?

You can click the graphic below for the historical numbers, but it shows that Baxter International had US$5.98b of debt in March 2021, down from US$6.76b, one year before. However, it does have US$3.18b in cash offsetting this, leading to net debt of about US$2.79b.

debt-equity-history-analysis
NYSE:BAX Debt to Equity History May 11th 2021

How Strong Is Baxter International's Balance Sheet?

The latest balance sheet data shows that Baxter International had liabilities of US$3.19b due within a year, and liabilities of US$7.79b falling due after that. Offsetting these obligations, it had cash of US$3.18b as well as receivables valued at US$1.99b due within 12 months. So its liabilities total US$5.81b more than the combination of its cash and short-term receivables.

Since publicly traded Baxter International shares are worth a very impressive total of US$43.6b, it seems unlikely that this level of liabilities would be a major 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.

Baxter International has a low net debt to EBITDA ratio of only 1.0. And its EBIT covers its interest expense a whopping 12.5 times over. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Baxter International saw its EBIT decline by 9.2% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Baxter International's ability to maintain a healthy balance sheet going forward. 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 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, Baxter International produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Baxter International's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its EBIT growth rate. We would also note that Medical Equipment industry companies like Baxter International commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that Baxter International 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Baxter International .

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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What are the risks and opportunities for Baxter International?

Baxter International Inc., through its subsidiaries, develops and provides a portfolio of healthcare products worldwide.

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Rewards

  • Trading at 40% below our estimate of its fair value

  • Earnings are forecast to grow 64.46% per year

Risks

  • Debt is not well covered by operating cash flow

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