Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Owens & Minor, Inc. (NYSE:OMI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Our analysis indicates that OMI is potentially undervalued!
What Is Owens & Minor's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2022 Owens & Minor had US$2.55b of debt, an increase on US$945.4m, over one year. However, because it has a cash reserve of US$76.8m, its net debt is less, at about US$2.47b.
A Look At Owens & Minor's Liabilities
Zooming in on the latest balance sheet data, we can see that Owens & Minor had liabilities of US$1.60b due within 12 months and liabilities of US$2.97b due beyond that. Offsetting these obligations, it had cash of US$76.8m as well as receivables valued at US$752.0m due within 12 months. So its liabilities total US$3.74b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$1.60b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Owens & Minor would probably need a major re-capitalization if its creditors were to demand repayment.
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.
With a net debt to EBITDA ratio of 5.1, it's fair to say Owens & Minor does have a significant amount of debt. However, its interest coverage of 3.2 is reasonably strong, which is a good sign. Worse, Owens & Minor's EBIT was down 27% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Owens & Minor'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Owens & Minor produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
To be frank both Owens & Minor's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. It's also worth noting that Owens & Minor is in the Healthcare industry, which is often considered to be quite defensive. Taking into account all the aforementioned factors, it looks like Owens & Minor has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. For example, we've discovered 4 warning signs for Owens & Minor (1 is potentially serious!) that you should be aware of before investing here.
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.
Valuation is complex, but we're helping make it simple.
Find out whether Owens & Minor is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.