AbbVie Inc. (NYSE:ABBV) carries a large amount of debt, with a 623% Debt to Equity ratio. They are also quite profitable with US$5b in net income amounting to a 10% profit margin.
We will try to see if the debt level is manageable and what does that mean for investors.
Why Does Debt Bring Risk?
Debt brings in fresh capital, but the interest payments are a fixed expense that have to be paid in good times and bad.
After a certain level of debt, financing with corporate bonds may become harder, as investors become afraid of the ability of AbbVie to re-pay the debt and start demanding higher interest. If prolonged, this phenomenon can feed off itself and put a lot of financial stress on a company.
An optimal capital structure creates value for investors, but having excess debt destroys it, and that is reflected in the stock price.
It is also prudent to know why a company is raising debt. Is it because it can't cover expenses, is paying out more than it can afford in dividends, is starting new projects, has unexpected expense items like lawsuit settlements, is it making a cash acquisition, does it gain a tax benefit?
Investors should be curious as to how much debt a company carries, as well as what is the purpose of that debt.
How Much Debt Does AbbVie Carry?
As you can see below, at the end of March 2021, AbbVie had US$84.5b of debt, up from US$67.1b a year ago. However, it also had US$9.78b in cash, and so its net debt is US$74.7b.
Click the image for more detail.
A Look At AbbVie's Liabilities
The latest balance sheet data shows that AbbVie had liabilities of US$32.0b due within a year, and liabilities of US$104.8b falling due after that. Offsetting this, it had US$9.78b in cash and US$9.59b in receivables that were due within 12 months. So, it has liabilities totaling US$117.4b more than its cash and near-term receivables, combined. This makes the short term picture less than optimal.
This deficit isn't so bad because AbbVie is worth a massive US$208.3b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, this would dilute some shares and it is still worthwhile taking a close look at its ability to pay off debt.
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.
AbbVie's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 6.6 times over.
Additionally, over the last three years, AbbVie actually produced more free cash flow than EBIT.
This suggests that while the debt levels are significant, they seem less problematic when looking at AbbVie's income capacity.
From a ratings' perspective, AbbVie's credit rating is "BBB+" according to S&P Global. Looking at the current interest coverage ratio and market cap, we could put AbbVie in the A2/A rating category - Of course, the company had a great year and that might be a reason why ratings agencies would want to wait a bit longer before upgrading to a higher rating.
Lastly, we want to know what is happening with the debt.
AbbVie' largest cash outflows (Q1 report, p 32) include US$198m to pay for the recent acquisition of Allergen, US$188m capital expenditures, US$2.3b dividend payments, US$1.8b aggregate principal debt repayment, another US$750m euro debt repayment, cash buybacks of US$1.05b.
We can see that the company is mostly using its assets to repay old debt, repurchase shares, make dividend payments and pay for acquisitions.
Acquisitions and share repurchase programs show as a loss of equity, and may frighten investors, but these figures should be taken with reserve because the acquired companies are now part of AbbVie and share buybacks deliver stock price gains.
We are currently seeing how AbbVie is handling debt in good times, with revenue growth and a rich product portfolio. AbbVie's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt.
As long as interest payments benefit the expenses and growth prospects for AbbVie, then debt is not a problem. However, it is not great to know that there is a possibility for shareholder dividends & stock buybacks to be financed with debt, and that might not be sustainable.
Acquisitions are big bets, and are hard to get right and pay a fair price. We hope that the latest acquisition will result in more profits than complexity for the company.
The balance sheet is clearly the area to focus on when you are analyzing debt. But ultimately, every company can contain risks that exist outside the balance sheet. For example, we've discovered 4 warning signs for AbbVie that you should be aware of before investing here.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. 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.