Here’s why AmerisourceBergen (NYSE:ABC) can manage its debt responsibly

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Warren Buffett said: “Volatility is far from synonymous with risk. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, AmerisourceBergen Corporation (NYSE:ABC) is in debt. But should shareholders worry about its use of debt?

Why is debt risky?

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 frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

What is AmerisourceBergen’s debt?

The image below, which you can click for more details, shows AmerisourceBergen had $6.46 billion in debt at the end of June 2022, a reduction from $7.10 billion year-over-year. However, he has $3.03 billion in cash to offset this, resulting in a net debt of approximately $3.42 billion.

NYSE: ABC Debt to Equity History August 5, 2022

A Look at AmerisourceBergen’s Responsibilities

According to the last published balance sheet, AmerisourceBergen had liabilities of US$43.2 billion due within 12 months and liabilities of US$13.5 billion due beyond 12 months. On the other hand, it had a cash position of 3.03 billion dollars and 18.2 billion dollars in receivables at less than one year. It therefore has liabilities totaling $35.4 billion more than its cash and short-term receivables, combined.

When you consider that this shortfall exceeds the company’s huge US$28.9 billion market capitalization, you might well be inclined to take a close look at the balance sheet. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.

In order to assess a company’s debt relative to its earnings, 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 expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

AmerisourceBergen’s net debt is only 0.96 times its EBITDA. And its EBIT covers its interest charges 13.7 times. So we’re pretty relaxed about his super-conservative use of debt. Another good sign, AmerisourceBergen was able to increase its EBIT by 24% in twelve months, thus facilitating the repayment of its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether AmerisourceBergen can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, AmerisourceBergen has generated free cash flow of a very strong 82% of EBIT, more than expected. This puts him in a very strong position to pay off the debt.

Our point of view

Fortunately, AmerisourceBergen’s impressive interest coverage means it has the upper hand on its debt. But we have to admit that we find that his level of total liabilities has the opposite effect. We also note that healthcare companies like AmerisourceBergen generally use debt without issue. All told, it looks like AmerisourceBergen can comfortably manage its current level of debt. On the plus side, this leverage can increase shareholder returns, but the potential downside is more risk of loss, so it’s worth keeping an eye on the balance sheet. 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. We have identified 2 warning signs with AmerisourceBergen, and understanding them should be part of your investment process.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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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.

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