Warren Buffett said: “Volatility is far from synonymous with risk. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Mostly, CVS Health Society (NYSE:CVS) is in debt. But should shareholders worry about its use of debt?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for CVS Health
What is CVS Health’s net debt?
You can click on the chart below for historical numbers, but it shows CVS Health had US$54.9 billion in debt in December 2021, up from US$63.6 billion a year prior. On the other hand, it has $12.5 billion in cash, resulting in a net debt of around $42.4 billion.
A Look at CVS Health’s Responsibilities
We can see from the most recent balance sheet that CVS Health had liabilities of $67.8 billion due in one year, and liabilities of $89.8 billion beyond. On the other hand, it had 12.5 billion dollars in cash and 24.4 billion dollars in receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by $120.7 billion.
This shortfall is sizable relative to its very large market capitalization of US$136.9 billion, so it suggests shareholders should monitor CVS Health’s use of debt. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
CVS Health’s net debt to EBITDA ratio of approximately 2.3 suggests only moderate debt utilization. And its strong interest coverage of 10.6 times makes us even more comfortable. Notably, CVS Health’s EBIT has been fairly stable over the past year. We would prefer to see some earnings growth as this always helps reduce debt. When analyzing debt levels, the balance sheet is the obvious starting point. But future earnings, more than anything, will determine CVS Health’s ability to maintain a healthy balance sheet in the future. 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. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Fortunately for all shareholders, CVS Health has actually produced more free cash flow than EBIT for the past three years. There’s nothing better than incoming money to stay in the good books of your lenders.
Our point of view
CVS Health’s conversion of EBIT to free cash flow was a real benefit in this analysis, as was its interest coverage. On the other hand, its level of total liabilities makes us a little less comfortable about its indebtedness. It should also be noted that CVS Health belongs to the healthcare industry, which is often seen as quite defensive. Given this range of data points, we believe CVS Health is in a good position to manage its level of leverage. But be warned: we believe debt levels are high enough to warrant continued monitoring. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we found 1 warning sign for CVS Health which you should be aware of before investing here.
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.