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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Thermo Fisher Scientific Inc. (NYSE:TMO) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Thermo Fisher Scientific

What Is Thermo Fisher Scientific's Net Debt?

The chart below, which you can click on for greater detail, shows that Thermo Fisher Scientific had US$35.0b in debt in December 2023; about the same as the year before. On the flip side, it has US$8.08b in cash leading to net debt of about US$26.9b.

How Strong Is Thermo Fisher Scientific's Balance Sheet?

We can see from the most recent balance sheet that Thermo Fisher Scientific had liabilities of US$14.0b falling due within a year, and liabilities of US$37.9b due beyond that. Offsetting these obligations, it had cash of US$8.08b as well as receivables valued at US$9.66b due within 12 months. So it has liabilities totalling US$34.1b more than its cash and near-term receivables, combined.

Given Thermo Fisher Scientific has a humongous market capitalization of US$228.6b, it's hard to believe these liabilities pose much 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that Thermo Fisher Scientific's moderate net debt to EBITDA ratio ( being 2.5), indicates prudence when it comes to debt. And its commanding EBIT of 14.9 times its interest expense, implies the debt load is as light as a peacock feather. Unfortunately, Thermo Fisher Scientific's EBIT flopped 14% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Thermo Fisher Scientific'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 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 78% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Thermo Fisher Scientific's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its EBIT growth rate. Looking at all the aforementioned factors together, it strikes us that Thermo Fisher Scientific 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Thermo Fisher Scientific that you should be aware of before investing here.

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.