These 4 Measures Indicate That Solventum (NYSE:SOLV) Is Using Debt Extensively

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. We can see that Solventum Corporation (NYSE:SOLV) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. 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.

Check out our latest analysis for Solventum

What Is Solventum's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Solventum had US$8.11b of debt, an increase on none, over one year. On the flip side, it has US$772.0m in cash leading to net debt of about US$7.34b.

How Healthy Is Solventum's Balance Sheet?

According to the last reported balance sheet, Solventum had liabilities of US$2.90b due within 12 months, and liabilities of US$8.65b due beyond 12 months. Offsetting this, it had US$772.0m in cash and US$1.33b in receivables that were due within 12 months. So its liabilities total US$9.45b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of US$12.2b, so it does suggest shareholders should keep an eye on Solventum's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Solventum's debt is 4.0 times its EBITDA, and its EBIT cover its interest expense 5.0 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Shareholders should be aware that Solventum's EBIT was down 22% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Solventum 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Solventum recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Neither Solventum's ability to grow its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. It's also worth noting that Solventum is in the Medical Equipment industry, which is often considered to be quite defensive. Taking the abovementioned factors together we do think Solventum's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. To that end, you should learn about the 2 warning signs we've spotted with Solventum (including 1 which is a bit concerning) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.