David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ 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. Importantly, Gilead Sciences, Inc. (NASDAQ:GILD) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Gilead Sciences’s Debt?
As you can see below, Gilead Sciences had US$25.0b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it also had US$7.97b in cash, and so its net debt is US$17.0b.
How Healthy Is Gilead Sciences’ Balance Sheet?
According to the last reported balance sheet, Gilead Sciences had liabilities of US$11.9b due within 12 months, and liabilities of US$28.2b due beyond 12 months. Offsetting these obligations, it had cash of US$7.97b as well as receivables valued at US$4.79b due within 12 months. So its liabilities total US$27.4b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Gilead Sciences has a huge market capitalization of US$94.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Gilead Sciences’s net debt is only 1.4 times its EBITDA. And its EBIT easily covers its interest expense, being 10.0 times the size. So we’re pretty relaxed about its super-conservative use of debt. On the other hand, Gilead Sciences’s EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Gilead Sciences can strengthen its balance sheet over time.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Gilead Sciences produced sturdy free cash flow equating to 78% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Gilead Sciences’s EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There’s no doubt that its ability to to convert EBIT to free cash flow is pretty flash. Looking at all this data makes us feel a little cautious about Gilead Sciences’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. The balance sheet is clearly the area to focus on when you are analysing debt.