Stock Analysis

Here's Why Avantor (NYSE:AVTR) Can Manage Its Debt Responsibly

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NYSE:AVTR
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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

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How Much Debt Does Avantor Carry?

You can click the graphic below for the historical numbers, but it shows that Avantor had US$4.52b of debt in March 2021, down from US$4.98b, one year before. However, it also had US$172.5m in cash, and so its net debt is US$4.35b.

debt-equity-history-analysis
NYSE:AVTR Debt to Equity History July 9th 2021

How Healthy Is Avantor's Balance Sheet?

The latest balance sheet data shows that Avantor had liabilities of US$1.24b due within a year, and liabilities of US$5.69b falling due after that. On the other hand, it had cash of US$172.5m and US$1.20b worth of receivables due within a year. So it has liabilities totalling US$5.56b more than its cash and near-term receivables, combined.

Avantor has a very large market capitalization of US$20.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Avantor's debt is 3.5 times its EBITDA, and its EBIT cover its interest expense 3.2 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Looking on the bright side, Avantor boosted its EBIT by a silky 38% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Avantor's ability to maintain a healthy balance sheet going forward. 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 we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Avantor recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Avantor's impressive EBIT growth rate implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its interest cover. Looking at all the aforementioned factors together, it strikes us that Avantor can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. Be aware that Avantor is showing 3 warning signs in our investment analysis , and 1 of those 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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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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