David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Bausch Health Companies Inc. (NYSE:BHC) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
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What Is Bausch Health Companies’s Debt?
You can click the graphic below for the historical numbers, but it shows that Bausch Health Companies had US$20.6b of debt in June 2023, down from US$21.8b, one year before. On the flip side, it has US$579.0m in cash leading to net debt of about US$20.0b.
A Look At Bausch Health Companies’ Liabilities
According to the last reported balance sheet, Bausch Health Companies had liabilities of US$3.97b due within 12 months, and liabilities of US$21.3b due beyond 12 months. Offsetting these obligations, it had cash of US$579.0m as well as receivables valued at US$1.74b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$22.9b.
The deficiency here weighs heavily on the US$2.48b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. At the end of the day, Bausch Health Companies would probably need a major re-capitalization if its creditors were to demand repayment.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Bausch Health Companies shareholders face the double whammy of a high net debt to EBITDA ratio (7.2), and fairly weak interest coverage, since EBIT is just 1.1 times the interest expense. The debt burden here is substantial. Another concern for investors might be that Bausch Health Companies’s EBIT fell 10% in the last year. If that’s the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Bausch Health Companies’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Bausch Health Companies created free cash flow amounting to 19% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
To be frank both Bausch Health Companies’s interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its EBIT growth rate fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Bausch Health Companies has too much debt. That sort of riskiness is ok for some, but it certainly doesn’t float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. To that end, you should be aware of the 1 warning sign we’ve spotted with Bausch Health Companies .
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.