We believe Amgen (NASDAQ: AMGN) can hold on to its debt level

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 it might be obvious that you need to consider debt when thinking about how risky a particular stock is, as too much debt can bring a company down. We make a note of that Amgen Inc. (NASDAQ: AMGN) has debt on its balance sheet. But should shareholders be concerned about the use of debt?

When is debt a problem?

Debt is a tool to help businesses grow, but when a business is unable to pay off its lenders it is at their mercy. An integral part of capitalism is the process of “creative destruction,” in which failed companies are mercilessly liquidated by their bankers. However, a more common (but still expensive) situation is that a company needs to water down shareholders on a cheap stock price just to get a grip on debt. Of course, debt can be an important tool in any business, especially in capital-intensive companies. When examining debt, we first look at both cash and debt levels together.

Check out our latest analysis for Amgen

What is Amgen’s net debt?

As you can see below, Amgen had $ 33.0 billion in debt at the end of December 2020, down from $ 29.9 billion a year ago. Click on the picture for more details. On the flip side, it has $ 10.6 billion in cash, which results in about $ 22.3 billion in net debt.

NasdaqGS: AMGN Debt-to-Equity History March 20, 2021

How strong is Amgen’s record?

If we zoom in on the latest balance sheet data, we can see that Amgen had $ 11.7 billion in debt and $ 41.9 billion in debt beyond that. To offset these commitments, the company had $ 10.6 billion in cash and $ 5.32 billion in receivables due within 12 months. So it has $ 37.6 billion in liabilities than its cash and short-term receivables combined.

While this may seem like a lot, it isn’t that bad as Amgen has a massive market cap of $ 142.0 billion, so it could likely bolster its balance sheet by raising capital if needed. But we definitely want to keep our eyes peeled for signs that debt is bringing too much risk.

To estimate a company’s debt in relation to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its interest expense (its interest coverage). The advantage of this approach is that we take into account both the absolute level of debt (with net debt to EBITDA) and the actual interest expenses associated with this debt (with its interest coverage ratio).

Amgen’s net debt of 1.7 times EBITDA suggests that debt is being used wisely. And the tempting interest coverage (EBIT of 9.0 times the interest expense) does it too not do everything possible to dissipate this impression. Unfortunately, Amgen posted a 4.0% decrease in EBIT over the past twelve months. If this earnings trend continues, its debt burden will be as heavy as the heart of a polar bear watching its only cub. Undoubtedly, we learn most about balance sheet debt. But ultimately, the company’s future profitability will determine whether Amgen can strengthen its balance sheet over time. So if you are focused on the future, this is what you can check out here for free Analyst earnings forecast report.

After all, a company can only pay off debts with cold money, not book profits. We therefore always check how much of this EBIT is converted into free cash flow. For the past three years, Amgen has had free cash flow of a whopping 98% of its EBIT, which is stronger than we would normally expect. That puts them in a very strong position to pay off debts.

Our view

The good news is that Amgen’s proven ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But to be honest, we think the EBIT growth rate undermines that impression a bit. If you look at all of the above factors together, we see that Amgen is quite comfortable with its debt. On the plus side, this leverage can increase shareholder returns, but the potential downside is a higher risk of loss, so it’s worth keeping an eye on the balance sheet. Undoubtedly, we learn most about balance sheet debt. However, not all of the investment risk is on the balance sheet – on the contrary. Case in point: we have discovered 2 warning signs for Amgen you should be aware.

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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