We Think Gilead Sciences (NASDAQ:GILD) Can Stay On Top Of Its Debt

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.' 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 can see that Gilead Sciences, Inc. (NASDAQ:GILD) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for Gilead Sciences

What Is Gilead Sciences's Debt?

The chart below, which you can click on for greater detail, shows that Gilead Sciences had US$25.2b in debt in June 2023; about the same as the year before. However, it does have US$7.10b in cash offsetting this, leading to net debt of about US$18.1b.

How Healthy Is Gilead Sciences' Balance Sheet?

The latest balance sheet data shows that Gilead Sciences had liabilities of US$14.0b due within a year, and liabilities of US$27.3b falling due after that. Offsetting these obligations, it had cash of US$7.10b as well as receivables valued at US$4.23b due within 12 months. So it has liabilities totalling US$29.9b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Gilead Sciences is worth a massive US$99.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Gilead Sciences's net debt is only 1.5 times its EBITDA. And its EBIT covers its interest expense a whopping 10.7 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that Gilead Sciences has seen its EBIT plunge 18% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Gilead Sciences 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 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. During the last three years, Gilead Sciences produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Gilead Sciences's conversion of EBIT to free cash flow was a real positive on this analysis, as was its interest cover. But truth be told its EBIT growth rate had us nibbling our nails. Considering this range of data points, we think Gilead Sciences is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. We've identified 2 warning signs with Gilead Sciences , and understanding them should be part of your investment process.

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.