David Iben put it well when he said: “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Above all, International Business Machines Corporation (NYSE: IBM) is in debt. But does this debt concern shareholders?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest review for International Business Machines
How much debt do international trade machines carry?
You can click on the chart below for historical numbers, but it shows that International Business Machines had $ 54.1 billion in debt in September 2021, up from $ 65.1 billion a year earlier. On the other hand, it has $ 8.06 billion in cash, resulting in net debt of around $ 46.1 billion.
How strong is International Business Machines’ balance sheet?
Zooming in on the latest balance sheet data, we can see that International Business Machines had a liability of US $ 35.8 billion owed within 12 months and a liability of US $ 86.0 billion owed beyond that. On the other hand, he had $ 8.06 billion in cash and $ 15.4 billion in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 98.4 billion.
That’s a mountain of leverage, even compared to its gargantuan market cap of US $ 104.1 billion. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization expenses.
With a net debt to EBITDA ratio of 2.9, International Business Machines has quite a significant amount of debt. On the positive side, its EBIT was 8.0 times its interest expense and its net debt to EBITDA was quite high, at 2.9. It is important to note that International Business Machines EBIT has remained essentially stable over the past twelve months. We would rather see some growth in earnings as it always helps reduce debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether International Business Machines 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.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Fortunately for all shareholders, International Business Machines has actually generated more free cash flow than EBIT over the past three years. This kind of cash conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
Based on our analysis, the conversion of EBIT to Free Cash Flow of International Business Machines should indicate that it will not have too many problems with its debt. However, our other observations were not so encouraging. For example, his total liability level makes us a little nervous about his debt. When we consider all of the factors mentioned above, we feel a little cautious about the use of debt by International Business Machines. While debt has its advantage in higher potential returns, we believe shareholders should definitely consider how leverage levels might make the stock riskier. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example – International Business Machines has 4 warning signs we think you should be aware.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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