Stock Analysis

These 4 Measures Indicate That Baxter International (NYSE:BAX) Is Using Debt Reasonably Well

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NYSE:BAX
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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 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. We can see that Baxter International Inc. (NYSE:BAX) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. 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.

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What Is Baxter International's Debt?

As you can see below, Baxter International had US$6.06b of debt at June 2021, down from US$6.59b a year prior. However, because it has a cash reserve of US$3.14b, its net debt is less, at about US$2.92b.

debt-equity-history-analysis
NYSE:BAX Debt to Equity History August 14th 2021

How Healthy Is Baxter International's Balance Sheet?

According to the last reported balance sheet, Baxter International had liabilities of US$3.34b due within 12 months, and liabilities of US$7.80b due beyond 12 months. Offsetting this, it had US$3.14b in cash and US$2.12b in receivables that were due within 12 months. So it has liabilities totalling US$5.89b more than its cash and near-term receivables, combined.

Since publicly traded Baxter International shares are worth a very impressive total of US$37.3b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Baxter International has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 13.2 times the size. So we're pretty relaxed about its super-conservative use of debt. While Baxter International doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

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 66% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Baxter International's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. We would also note that Medical Equipment industry companies like Baxter International commonly do use debt without problems. Taking all this data into account, it seems to us that Baxter International takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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 .

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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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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