These 4 Measures Indicate That Quest Diagnostics (NYSE:DGX) Is Using Debt Reasonably Well

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 Quest Diagnostics Incorporated (NYSE:DGX) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Quest Diagnostics

How Much Debt Does Quest Diagnostics Carry?

The chart below, which you can click on for greater detail, shows that Quest Diagnostics had US$4.41b in debt in June 2024; about the same as the year before. However, it does have US$271.0m in cash offsetting this, leading to net debt of about US$4.13b.

A Look At Quest Diagnostics' Liabilities

Zooming in on the latest balance sheet data, we can see that Quest Diagnostics had liabilities of US$2.01b due within 12 months and liabilities of US$5.13b due beyond that. Offsetting these obligations, it had cash of US$271.0m as well as receivables valued at US$1.32b due within 12 months. So its liabilities total US$5.56b more than the combination of its cash and short-term receivables.

Quest Diagnostics has a very large market capitalization of US$17.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Quest Diagnostics's net debt of 2.3 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.0 times interest expense) certainly does not do anything to dispel this impression. Quest Diagnostics grew its EBIT by 2.5% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Quest Diagnostics 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.

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. Over the most recent three years, Quest Diagnostics recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Quest Diagnostics's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And we also thought its interest cover was a positive. We would also note that Healthcare industry companies like Quest Diagnostics commonly do use debt without problems. All these things considered, it appears that Quest Diagnostics can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Quest Diagnostics .

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.