We think Cigna (NYSE: CI) is taking risks with its debt

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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 risk.” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Above all, Cigna Company (NYSE: CI) is in debt. But the real question is whether this debt makes the business risky.

When is debt dangerous?

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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a company’s debt levels is to consider its cash flow and debt together.

See our latest review for Cigna

What is Cigna’s net debt?

The image below, which you can click for more details, shows that Cigna had a debt of US $ 33.1 billion at the end of June 2021, a reduction from US $ 36.5 billion on a year. However, it has $ 5.07 billion in cash offsetting that, leading to net debt of around $ 28.0 billion.

NYSE: CI Debt to Equity History November 4, 2021

How strong is Cigna’s balance sheet?

According to the latest published balance sheet, Cigna had liabilities of US $ 34.7 billion due within 12 months and liabilities of US $ 70.7 billion due beyond 12 months. On the other hand, he had $ 5.07 billion in cash and $ 15.5 billion in receivables due within a year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 84.9 billion.

Given that this deficit is actually greater than the company’s massive market cap of $ 74.2 billion, we think shareholders should really watch Cigna’s debt levels, like a parent watching their child do. cycling for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer a significant dilution.

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we consider debt versus earnings with and without amortization charges.

Cigna has a debt to EBITDA ratio of 2.8 and its EBIT covers its interest expense 6.6 times. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. The bad news is that Cigna has seen its EBIT drop by 11% over the past year. If incomes continue to drop at this rate, it will be more difficult to manage debt than taking three kids under 5 to a fancy pants restaurant. There is no doubt that we learn the most about debt from the balance sheet. But it’s future profits, more than anything, that will determine Cigna’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

Finally, a business can only pay off its debts with hard cash, not with book profits. 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, Cigna has recorded free cash flow of 76% 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

Cigna’s total liability level and EBIT growth rate certainly weighs on this, in our view. But his conversion from EBIT to free cash tells a very different story and suggests some resilience. It’s also worth noting that Cigna belongs to the healthcare industry, which is often seen as quite defensive. When we consider all the factors mentioned, it seems to us that Cigna is taking risks with its recourse to debt. While this debt may increase returns, we believe the company now has sufficient leverage. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example Cigna has 2 warning signs (and 1 which is potentially serious) we think you should be aware of.

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

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 shares 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 the mentioned stocks.

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