Stock Analysis

Avantor (NYSE:AVTR) Has A Pretty Healthy Balance Sheet

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NYSE:AVTR
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Avantor, Inc. (NYSE:AVTR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Avantor

What Is Avantor's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Avantor had debt of US$5.51b, up from US$5.00b in one year. However, it also had US$1.43b in cash, and so its net debt is US$4.09b.

debt-equity-history-analysis
NYSE:AVTR Debt to Equity History February 4th 2022

How Healthy Is Avantor's Balance Sheet?

According to the last reported balance sheet, Avantor had liabilities of US$1.32b due within 12 months, and liabilities of US$6.77b due beyond 12 months. On the other hand, it had cash of US$1.43b and US$1.18b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.48b.

While this might seem like a lot, it is not so bad since Avantor has a huge market capitalization of US$23.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Avantor has a debt to EBITDA ratio of 2.9 and its EBIT covered its interest expense 4.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Importantly, Avantor grew its EBIT by 58% over the last twelve months, and that growth will make it easier to handle its debt. 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 Avantor 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Avantor generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Avantor's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Taking all this data into account, it seems to us that Avantor takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For example, we've discovered 4 warning signs for Avantor (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

What are the risks and opportunities for Avantor?

Avantor, Inc. provides products and services to customers in biopharma, healthcare, education and government, advanced technologies, and applied materials industries in the Americas, Europe, Asia, the Middle East, and Africa.

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Rewards

  • Price-To-Earnings ratio (26.5x) is below the Life Sciences industry average (31.1x)

  • Earnings are forecast to grow 12.26% per year

  • Earnings grew by 28.5% over the past year

Risks

  • Debt is not well covered by operating cash flow

  • Shareholders have been diluted in the past year

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