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. Importantly, ABB Ltd (VTX:ABBN) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
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What Is ABB's Debt?
The chart below, which you can click on for greater detail, shows that ABB had US$10.2b in debt in June 2019; about the same as the year before. On the flip side, it has US$3.23b in cash leading to net debt of about US$6.93b.
A Look At ABB's Liabilities
Zooming in on the latest balance sheet data, we can see that ABB had liabilities of US$19.2b due within 12 months and liabilities of US$12.9b due beyond that. Offsetting these obligations, it had cash of US$3.23b as well as receivables valued at US$7.68b due within 12 months. So it has liabilities totalling US$21.2b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since ABB has a huge market capitalization of US$43.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
ABB's net debt to EBITDA ratio of about 2.2 suggests only moderate use of debt. And its strong interest cover of 18.5 times, makes us even more comfortable. If ABB can keep growing EBIT at last year's rate of 12% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if ABB can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.