David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Baxter International Inc. (NYSE: BAX) uses debt in its operations. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Baxter International
What is Baxter International’s net debt?
The image below, which you can click on for more details, shows that as of December 2021, Baxter International had $17.6 billion in debt, up from $6.13 billion in one year. On the other hand, it has $2.95 billion in cash, resulting in a net debt of around $14.6 billion.
How strong is Baxter International’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Baxter International had liabilities of US$4.24 billion due within 12 months and liabilities of US$20.2 billion due beyond. In compensation for these obligations, it had cash of 2.95 billion US dollars as well as receivables valued at 2.71 billion US dollars due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by $18.7 billion.
Baxter International has a very large market capitalization of US$39.5 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Baxter International has a debt to EBITDA ratio of 4.9, which signals significant debt, but is still fairly reasonable for most types of businesses. However, its interest coverage of 10.9 is very high, suggesting that debt interest charges are currently quite low. One way for Baxter International to overcome its debt would be to stop borrowing more but continue to grow EBIT by around 11%, as it did last year. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Baxter International can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Baxter International has produced strong free cash flow equivalent to 70% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Baxter International’s interest cover suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But we have to admit that we see that its net debt to EBITDA has the opposite effect. We would also like to note that companies in the medical equipment industry like Baxter International commonly use debt without issue. All in all, it looks like Baxter International can comfortably manage its current level of debt. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that Baxter International shows 2 warning signs in our investment analysis and 1 of them makes us a little uncomfortable…
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.