Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Elevance Health Inc. (NYSE:ELV) makes use of debt. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Elevance Health’s Net Debt?
The chart below, which you can click on for greater detail, shows that Elevance Health had US$23.0b in debt in September 2022; about the same as the year before. However, its balance sheet shows it holds US$35.9b in cash, so it actually has US$12.9b net cash.
How Strong Is Elevance Health’s Balance Sheet?
We can see from the most recent balance sheet that Elevance Health had liabilities of US$41.3b falling due within a year, and liabilities of US$25.7b due beyond that. Offsetting these obligations, it had cash of US$35.9b as well as receivables valued at US$14.2b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$16.9b.
Given Elevance Health has a humongous market capitalization of US$122.7b, it’s hard to believe these liabilities pose much threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Elevance Health also has more cash than debt, so we’re pretty confident it can manage its debt safely.
And we also note warmly that Elevance Health grew its EBIT by 14% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Elevance Health can strengthen its balance sheet over time.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Elevance Health may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Elevance Health actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Although Elevance Health’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$12.9b. The cherry on top was that in converted 105% of that EBIT to free cash flow, bringing in US$10b. So we don’t think Elevance Health’s use of debt is risky.