Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Bristol-Myers Squibb Company (NYSE:BMY) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

What Is Bristol-Myers Squibb's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Bristol-Myers Squibb had debt of US$55.7b, up from US$37.9b in one year. However, it also had US$9.67b in cash, and so its net debt is US$46.1b.

How Healthy Is Bristol-Myers Squibb's Balance Sheet?

We can see from the most recent balance sheet that Bristol-Myers Squibb had liabilities of US$25.8b falling due within a year, and liabilities of US$56.7b due beyond that. Offsetting these obligations, it had cash of US$9.67b as well as receivables valued at US$14.1b due within 12 months. So its liabilities total US$58.8b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of US$82.8b, so it does suggest shareholders should keep an eye on Bristol-Myers Squibb's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Bristol-Myers Squibb has a debt to EBITDA ratio of 2.5, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 10.8 is very high, suggesting that the interest expense on the debt is currently quite low. The bad news is that Bristol-Myers Squibb saw its EBIT decline by 13% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Bristol-Myers Squibb 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Bristol-Myers Squibb 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

Both Bristol-Myers Squibb's ability to to convert EBIT to free cash flow and its interest cover gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to grow its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Bristol-Myers Squibb's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Bristol-Myers Squibb you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com