These 4 Measures Indicate That Teva Pharmaceutical Industries (NYSE:TEVA) Is Using Debt Extensively

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Teva Pharmaceutical Industries Limited (NYSE:TEVA) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Teva Pharmaceutical Industries

What Is Teva Pharmaceutical Industries's Net Debt?

The image below, which you can click on for greater detail, shows that Teva Pharmaceutical Industries had debt of US$22.1b at the end of June 2022, a reduction from US$25.1b over a year. On the flip side, it has US$2.06b in cash leading to net debt of about US$20.0b.

A Look At Teva Pharmaceutical Industries' Liabilities

We can see from the most recent balance sheet that Teva Pharmaceutical Industries had liabilities of US$11.0b falling due within a year, and liabilities of US$25.1b due beyond that. Offsetting these obligations, it had cash of US$2.06b as well as receivables valued at US$4.47b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$29.6b.

The deficiency here weighs heavily on the US$11.2b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Teva Pharmaceutical Industries would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Teva Pharmaceutical Industries has a debt to EBITDA ratio of 4.7 and its EBIT covered its interest expense 3.3 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Given the debt load, it's hardly ideal that Teva Pharmaceutical Industries's EBIT was pretty flat over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Teva Pharmaceutical Industries'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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Teva Pharmaceutical Industries reported free cash flow worth 14% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over Teva Pharmaceutical Industries's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least its EBIT growth rate is not so bad. After considering the datapoints discussed, we think Teva Pharmaceutical Industries has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Even though Teva Pharmaceutical Industries lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

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.

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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.