Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Bausch + Lomb Corporation (NYSE:BLCO) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

How Much Debt Does Bausch + Lomb Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Bausch + Lomb had debt of US$4.58b, up from US$2.53b in one year. However, it also had US$315.0m in cash, and so its net debt is US$4.27b.

How Healthy Is Bausch + Lomb's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Bausch + Lomb had liabilities of US$1.62b due within 12 months and liabilities of US$4.95b due beyond that. On the other hand, it had cash of US$315.0m and US$960.0m worth of receivables due within a year. So its liabilities total US$5.29b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$5.26b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.67 times and a disturbingly high net debt to EBITDA ratio of 7.0 hit our confidence in Bausch + Lomb like a one-two punch to the gut. The debt burden here is substantial. On the other hand, Bausch + Lomb grew its EBIT by 24% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Bausch + Lomb's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Bausch + Lomb produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

While Bausch + Lomb's net debt to EBITDA makes us cautious about it, its track record of covering its interest expense with its EBIT is no better. But at least its EBIT growth rate is a gleaming silver lining to those clouds. We should also note that Medical Equipment industry companies like Bausch + Lomb commonly do use debt without problems. Looking at all the angles mentioned above, it does seem to us that Bausch + Lomb is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Case in point: We've spotted 1 warning sign for Bausch + Lomb you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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