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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. We can see that Anthem, Inc. (NYSE:ANTM) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Anthem Carry?
The image below, which you can click on for greater detail, shows that at June 2021 Anthem had debt of US$23.2b, up from US$21.5b in one year. But it also has US$32.9b in cash to offset that, meaning it has US$9.61b net cash.
How Healthy Is Anthem's Balance Sheet?
According to the last reported balance sheet, Anthem had liabilities of US$33.8b due within 12 months, and liabilities of US$27.3b due beyond 12 months. Offsetting these obligations, it had cash of US$32.9b as well as receivables valued at US$12.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$15.6b.
Of course, Anthem has a titanic market capitalization of US$92.0b, so these liabilities are probably manageable. 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, Anthem also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Anthem's EBIT dived 12%, 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 Anthem 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Anthem 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, Anthem recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While Anthem does have more liabilities than liquid assets, it also has net cash of US$9.61b. And it impressed us with free cash flow of US$5.8b, being 85% of its EBIT. So we don't have any problem with Anthem's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Anthem you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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.
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