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 note that Abbott Laboratories (NYSE:ABT) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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.
Check out our latest analysis for Abbott Laboratories
What Is Abbott Laboratories’s Net Debt?
The image below, which you can click on for greater detail, shows that Abbott Laboratories had debt of US$16.6b at the end of September 2022, a reduction from US$18.1b over a year. However, because it has a cash reserve of US$9.91b, its net debt is less, at about US$6.67b.
A Look At Abbott Laboratories’ Liabilities
According to the last reported balance sheet, Abbott Laboratories had liabilities of US$13.4b due within 12 months, and liabilities of US$23.6b due beyond 12 months. Offsetting these obligations, it had cash of US$9.91b as well as receivables valued at US$6.41b due within 12 months. So it has liabilities totalling US$20.6b more than its cash and near-term receivables, combined.
Of course, Abbott Laboratories has a titanic market capitalization of US$195.0b, so these liabilities are probably manageable. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse.
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 0.55 times its EBITDA. And its EBIT easily covers its interest expense, being 23.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Abbott Laboratories saw its EBIT decline by 5.0% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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, 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, Abbott Laboratories generated free cash flow amounting to a very robust 97% of its EBIT, more than we’d expect. That positions it well to pay down debt if desirable to do so.
Our View
The good news is that Abbott Laboratories’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. It’s also worth noting that Abbott Laboratories is in the Medical Equipment industry, which is often considered to be quite defensive. Looking at the bigger picture, we think Abbott Laboratories’s use of debt seems quite reasonable and we’re not concerned about it. After all, sensible leverage can boost returns on equity. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Abbott Laboratories is showing 1 warning sign in our investment analysis , you should know about…
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.
What are the risks and opportunities for Abbott Laboratories?
Abbott Laboratories, together with its subsidiaries, discovers, develops, manufactures, and sells health care products worldwide.
Rewards
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Trading at 27.6% below our estimate of its fair value
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Earnings are forecast to grow 4.43% per year
Risks
No risks detected for ABT from our risks checks.
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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.
