Owens & Minor (NYSE:OMI) Use Of Debt Could Be Considered Risky

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Owens & Minor, Inc. (NYSE:OMI) does use debt in its business. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Owens & Minor

What Is Owens & Minor's Debt?

As you can see below, at the end of December 2022, Owens & Minor had US$2.47b of debt, up from US$936.2m a year ago. Click the image for more detail. However, it also had US$69.5m in cash, and so its net debt is US$2.40b.

A Look At Owens & Minor's Liabilities

We can see from the most recent balance sheet that Owens & Minor had liabilities of US$1.57b falling due within a year, and liabilities of US$2.87b due beyond that. Offsetting this, it had US$69.5m in cash and US$763.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.61b.

The deficiency here weighs heavily on the US$1.04b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. 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.

Weak interest cover of 1.5 times and a disturbingly high net debt to EBITDA ratio of 5.9 hit our confidence in Owens & Minor like a one-two punch to the gut. The debt burden here is substantial. Worse, Owens & Minor's EBIT was down 52% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Owens & Minor 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Owens & Minor recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Owens & Minor (1 is potentially serious) you should be aware of.

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.