Yahoo Finance These 4 Measures Indicate That CVS Health (NYSE:CVS) Is Using Debt Reasonably Well
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that CVS Health Corporation (NYSE:CVS) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for CVS Health
What Is CVS Health's Debt?
As you can see below, CVS Health had US$58.2b of debt, at March 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$17.7b in cash offsetting this, leading to net debt of about US$40.5b.
A Look At CVS Health's Liabilities
The latest balance sheet data shows that CVS Health had liabilities of US$75.1b due within a year, and liabilities of US$92.7b falling due after that. Offsetting this, it had US$17.7b in cash and US$28.3b in receivables that were due within 12 months. So its liabilities total US$121.7b more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's massive market capitalization of US$89.3b, we think shareholders really should watch CVS Health's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).
We'd say that CVS Health's moderate net debt to EBITDA ratio ( being 2.1), indicates prudence when it comes to debt. And its strong interest cover of 11.6 times, makes us even more comfortable. We saw CVS Health grow its EBIT by 2.4% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CVS Health can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, CVS Health actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our View
CVS Health's conversion of EBIT to free cash flow was a real positive on this analysis, as was its interest cover. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. We would also note that Healthcare industry companies like CVS Health commonly do use debt without problems. Looking at all this data makes us feel a little cautious about CVS Health's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for CVS Health that you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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