Does Koninklijke Philips (AMS: PHIA) use too much debt?

Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. Above all, Koninklijke Philips NV (AMS: PHIA) carries a debt. But does this debt worry shareholders?

What risk does debt entail?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a business’s debt levels is to consider its cash flow and debt together.

Check out our latest review for Koninklijke Philips

What is Koninklijke Philips net debt?

The image below, which you can click for more details, shows that in June 2021 Koninklijke Philips had a debt of 7.83 billion euros, compared to 7.30 billion euros in a year. However, he has € 1.00 billion in cash to compensate for this, leading to net debt of around € 6.83 billion.

ENXTAM: PHIA History of debt to equity December 8, 2021

How healthy is Koninklijke Philips’ balance sheet?

Zooming in on the latest balance sheet data, we can see that Koninklijke Philips had a liability of € 8.77 billion due within 12 months and a liability of € 8.25 billion due beyond. In compensation for these obligations, he had cash of 1.00 billion euros as well as receivables valued at 3.51 billion euros within 12 months. It therefore has liabilities totaling 12.5 billion euros more than its combined cash and short-term receivables.

This deficit is not that big as Koninklijke Philips is worth 27.9 billion euros and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.

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). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Koninklijke Philips has a debt to EBITDA ratio of 2.9, which signals significant debt, but is still fairly reasonable for most types of businesses. But its EBIT was around 12.2 times its interest expense, implying that the company isn’t really paying a high cost to maintain that level of debt. Even if the low cost turns out to be unsustainable, that’s a good sign. It is important to note that Koninklijke Philips’ EBIT has fallen by 21% in the last twelve months. If this profit trend continues, paying off debt will be about as easy as driving cats on a roller coaster. When analyzing debt levels, the balance sheet is the obvious place to start. But it is future profits, more than anything, that will determine Koninklijke Philips’ ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free Analyst Profit 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. Over the past three years Koninklijke Philips has recorded free cash flow of 79% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This hard cash allows him to reduce his debt whenever he wants.

Our point of view

From what we have seen, Koninklijke Philips does not find it easy, given its EBIT growth rate, but the other factors we have taken into account give us cause for optimism. In particular, we are blown away by its coverage of interest. We also note that companies in the medical equipment sector like Koninklijke Philips generally use debt without a problem. Looking at all this data, we feel a little cautious about Koninklijke Philips’ debt levels. While we understand that debt can improve returns on equity, we suggest shareholders watch their debt level closely, lest they increase. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example, Koninklijke Philips has 4 warning signs (and 1 which doesn’t suit us very well) we think you should be aware of.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.

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 any stock 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 any of the stocks mentioned.

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