We Think Thermo Fisher Scientific (NYSE:TMO) Can Stay On Top Of Its Debt

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. As with many other companies Thermo Fisher Scientific Inc. (NYSE:TMO) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that TMO is potentially undervalued!

What Is Thermo Fisher Scientific's Debt?

You can click the graphic below for the historical numbers, but it shows that as of July 2022 Thermo Fisher Scientific had US$30.3b of debt, an increase on US$18.8b, over one year. However, it also had US$1.89b in cash, and so its net debt is US$28.4b.

How Healthy Is Thermo Fisher Scientific's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Thermo Fisher Scientific had liabilities of US$11.0b due within 12 months and liabilities of US$37.1b due beyond that. Offsetting this, it had US$1.89b in cash and US$8.89b in receivables that were due within 12 months. So it has liabilities totalling US$37.3b more than its cash and near-term receivables, combined.

Since publicly traded Thermo Fisher Scientific shares are worth a very impressive total of US$197.9b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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

Thermo Fisher Scientific's net debt to EBITDA ratio of about 2.2 suggests only moderate use of debt. And its strong interest cover of 19.4 times, makes us even more comfortable. Unfortunately, Thermo Fisher Scientific saw its EBIT slide 9.8% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Thermo Fisher Scientific 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Thermo Fisher Scientific produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Thermo Fisher Scientific's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. All these things considered, it appears that Thermo Fisher Scientific can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. Case in point: We've spotted 2 warning signs for Thermo Fisher Scientific you should be aware of.

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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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.