Is ABB (VTX:ABBN) using too much debt?
David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies ABB AG (VTX: ABBN) uses debt. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
Discover our latest analysis for ABB
What is ABB’s debt?
You can click on the chart below for historical figures, but it shows ABB had US$5.51 billion in debt in December 2021, up from US$5.94 billion a year earlier. On the other hand, it has $5.34 billion in cash, resulting in a net debt of around $172.0 million.
How healthy is ABB’s balance sheet?
The latest balance sheet data shows that ABB had liabilities of $15.6 billion due within the year, and liabilities of $8.74 billion due thereafter. In return, it had $5.34 billion in cash and $7.54 billion in receivables due within 12 months. It therefore has liabilities totaling $11.4 billion more than its cash and short-term receivables, combined.
Given that ABB has a colossal market capitalization of $68.6 billion, it’s hard to believe that these liabilities pose a threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time. Having practically no net debt, ABB has indeed a very light indebtedness.
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.
ABB has very modest net debt levels, with net debt at just 0.037 times EBITDA. Humorously, he actually received more interest in the last twelve months than he had to pay. So there’s no doubt that this company can go into debt as easily as enthusiastic self-tanners take on an orange hue. Even better, ABB increased its EBIT by 108% last year, which is an impressive improvement. This boost will make it even easier to pay off debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether ABB 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, ABB has produced strong free cash flow equivalent to 63% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
ABB’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And this is only the beginning of good news since its EBIT growth rate is also very encouraging. Given this set of factors, we believe that ABB is quite cautious with its debt, and the risks seem well controlled. The balance sheet therefore seems rather healthy to us. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 2 warning signs for ABB you should be aware, and one of them is a bit of a concern.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.