Air Products and Chemicals (NYSE:APD) Has A Pretty Healthy Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Air Products and Chemicals, Inc. (NYSE:APD) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Air Products and Chemicals

What Is Air Products and Chemicals's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Air Products and Chemicals had US$7.54b of debt in March 2022, down from US$8.04b, one year before. However, it also had US$3.21b in cash, and so its net debt is US$4.33b.

How Strong Is Air Products and Chemicals' Balance Sheet?

We can see from the most recent balance sheet that Air Products and Chemicals had liabilities of US$3.21b falling due within a year, and liabilities of US$9.73b due beyond that. Offsetting this, it had US$3.21b in cash and US$2.01b in receivables that were due within 12 months. So its liabilities total US$7.72b more than the combination of its cash and short-term receivables.

Of course, Air Products and Chemicals has a titanic market capitalization of US$49.6b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Air Products and Chemicals's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 17.8 times the size. So we're pretty relaxed about its super-conservative use of debt. The good news is that Air Products and Chemicals has increased its EBIT by 4.6% over twelve months, which should ease any concerns about debt repayment. 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 Air Products and Chemicals can strengthen its balance sheet over time. 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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Air Products and Chemicals's free cash flow amounted to 31% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On our analysis Air Products and Chemicals's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. Considering this range of data points, we think Air Products and Chemicals is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Case in point: We've spotted 1 warning sign for Air Products and Chemicals 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.