Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Abbott Laboratories (NYSE:ABT) does carry debt. But should shareholders be worried about its use of debt?
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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Abbott Laboratories
As you can see below, Abbott Laboratories had US$16.8b of debt at June 2022, down from US$18.5b a year prior. However, because it has a cash reserve of US$9.29b, its net debt is less, at about US$7.55b.
We can see from the most recent balance sheet that Abbott Laboratories had liabilities of US$12.4b falling due within a year, and liabilities of US$25.1b due beyond that. Offsetting this, it had US$9.29b in cash and US$7.20b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$21.0b.
Of course, Abbott Laboratories has a titanic market capitalization of US$185.2b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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.
Abbott Laboratories's net debt is only 0.54 times its EBITDA. And its EBIT easily covers its interest expense, being 22.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Abbott Laboratories has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. 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 Abbott Laboratories's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
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, Abbott Laboratories generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Happily, Abbott Laboratories's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! We would also note that Medical Equipment industry companies like Abbott Laboratories commonly do use debt without problems. It looks Abbott Laboratories has no trouble standing on its own two feet, and it has no reason to fear its lenders. To our minds it has a healthy happy 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. To that end, you should be aware of the 2 warning signs we've spotted with Abbott Laboratories .
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.
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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.
Find out whether Abbott Laboratories is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
Simply Wall St's Editorial Team provides unbiased, factual reporting on global stocks using in-depth fundamental analysis.
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Abbott Laboratories, together with its subsidiaries, discovers, develops, manufactures, and sells health care products worldwide.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
Read more about these checks in the individual report sections or in our analysis model.
Undervalued with solid track record.
Simply Wall St's Editorial Team provides unbiased, factual reporting on global stocks using in-depth fundamental analysis.
Find out more about our editorial guidelines and team.
Abbott Laboratories, together with its subsidiaries, discovers, develops, manufactures, and sells health care products worldwide.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
Read more about these checks in the individual report sections or in our analysis model.
Undervalued with solid track record.
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