Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Omnicom Group Inc. (NYSE:OMC) is in debt. But does this debt worry shareholders?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Omnicom Group
What is Omnicom Group’s debt?
As you can see below, Omnicom Group had US$5.28 billion in debt as of September 2021, up from US$5.79 billion the previous year. However, he has $4.43 billion in cash to offset this, resulting in a net debt of approximately $850.7 million.
A look at the responsibilities of the Omnicom Group
Zooming in on the latest balance sheet data, we can see that Omnicom Group had liabilities of US$13.8 billion due within 12 months and liabilities of US$7.72 billion due beyond. In return, it had $4.43 billion in cash and $7.19 billion in receivables due within 12 months. Thus, its liabilities total $9.93 billion more than the combination of its cash and short-term receivables.
That’s a mountain of leverage, even compared to its gargantuan market capitalization of US$15.9 billion. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Omnicom Group has a low net debt to EBITDA ratio of just 0.39. And its EBIT easily covers its interest costs, which is 11.3 times the size. So we’re pretty relaxed about his super conservative use of debt. The good news is that Omnicom Group increased its EBIT by 7.3% year-on-year, which should ease any worries about debt repayment. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Omnicom Group can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Omnicom Group has generated free cash flow of a very strong 93% of its EBIT, more than expected. This positions him well to pay off debt if desired.
Our point of view
The good news is that Omnicom Group’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a darker note, we’re a bit concerned about his total passive level. When we consider the range of factors above, it seems that Omnicom Group is quite sensible with its use of debt. While this carries some risk, it can also improve shareholder returns. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example – Omnicom Group has 1 warning sign we think you should know.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.