Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Lonza Group Ltd (VTX:LONN) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Lonza Group
What Is Lonza Group's Debt?
As you can see below, Lonza Group had CHF3.77b of debt at June 2019, down from CHF4.22b a year prior. On the flip side, it has CHF413.0m in cash leading to net debt of about CHF3.36b.
A Look At Lonza Group's Liabilities
According to the last reported balance sheet, Lonza Group had liabilities of CHF2.25b due within 12 months, and liabilities of CHF4.99b due beyond 12 months. On the other hand, it had cash of CHF413.0m and CHF775.0m worth of receivables due within a year. So its liabilities total CHF6.06b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Lonza Group has a huge market capitalization of CHF25.5b, 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
With a debt to EBITDA ratio of 2.2, Lonza Group uses debt artfully but responsibly. And the alluring interest cover (EBIT of 7.1 times interest expense) certainly does not do anything to dispel this impression. Lonza Group grew its EBIT by 8.4% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Lonza Group 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.