Legendary fund manager Li Lu (who was assisted by Charlie Munger) once said: “The greatest risk to investment is not price volatility, it is whether you suffer permanent capital loss.” So smart money seems to know that debt – which is usually associated with bankruptcies – is a very important factor in assessing how risky a company is. We make a note of that Thermo Fisher Scientific Inc. (NYSE: TMO) has debt on its balance sheet. But does this debt worry shareholders?
What is the risk of debt?
Debt is a tool to help businesses grow, but when a business is unable to pay off its lenders it is at their mercy. When things get really bad, lenders can take control of the business. While this isn’t too common, we often see indebted companies permanently diluting their shareholders by forcing lenders to raise capital at a distressed price. Of course, many companies use debt to fund their growth without any negative consequences. When examining debt, we first look at both cash and debt together.
What is Thermo Fisher Scientific’s debt?
The image below, which you can click for more details, shows that Thermo Fisher Scientific was in debt of $ 21.8 billion in December 2020, up from $ 17.8 billion in a year. On the flip side, it has $ 10.3 billion in cash, which results in about $ 11.5 billion in net debt.
A look at Thermo Fisher Scientific’s liabilities
If we zoom in on the latest balance sheet data, we can see that Thermo Fisher Scientific had $ 10.3 billion in debt and $ 24.2 billion in debt beyond that. On the flip side, it had $ 10.3 billion in cash and $ 6.47 billion in receivables due within one year. So it has total liabilities of $ 17.7 billion more than its cash and short-term receivables combined.
Of course, Thermo Fisher Scientific has a gigantic market cap of $ 175.8 billion, so these liabilities are likely to be manageable. However, we think it’s worth keeping an eye on balance sheet strength as it can change over time.
We measure a company’s debt burden in relation to its profitability by looking at net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily earnings before interest and taxes (EBIT) cover its interest costs (Interest coverage). In this way we take into account both the absolute amount of the debt and the interest paid on it.
Thermo Fisher Scientific has a low net debt to EBITDA ratio of just 1.1. And his EBIT easily covers 16.1 times as much interest expense. So we’re pretty relaxed about the super conservative approach to debt. We are also pleased to announce that Thermo Fisher Scientific has increased EBIT by 85%, reducing the specter of future debt payments. Undoubtedly, we learn most about balance sheet debt. But ultimately, the company’s future profitability will determine whether Thermo Fisher Scientific can strengthen its balance sheet over time. So if you want to see what the pros think, you might find this free analyst earnings forecast report to be interesting.
But our final consideration is also important because a company cannot pay its debts with paper profits; it takes cold cash. We therefore always check how much of this EBIT is converted into free cash flow. For the past three years, Thermo Fisher Scientific generated a very robust free cash flow of 91% of its EBIT, more than we expected. That puts them in a very strong position to pay off debts.
The good news is that Thermo Fisher Scientific’s proven ability to use EBIT to recover its interest expenses delights us like a fluffy puppy does a toddler. And the good news doesn’t stop there, because the conversion of EBIT into free cash flow also supports this impression! Overall, we assume that Thermo Fisher Scientific will not take any major risks as the debt burden appears modest. So we don’t worry about using a small leverage on the balance sheet. When analyzing debt levels, the obvious starting point is the balance sheet. However, not all of the investment risk is on the balance sheet – on the contrary. For example we identified 2 warning signs for Thermo Fisher Scientific that you should know.
After all that, if you’re more interested in a fast-growing company with a rock-solid balance sheet, then drop by our list of net cash growth stocks without delay.
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