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Why Merck’s Leverage is Important to Investors

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Jun. 24 2015, Updated 8:06 a.m. ET

Merck’s leverage

American pharmaceutical giant Merck & Co. (MRK) operates worldwide, using equity and debt for its working capital requirements. It also uses equity and debt for its investments.

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Net debt to EBIDTA

Net debt to EBITDA (or earnings before interest, tax, depreciation, and amortization) measures leverage, calculated as a company’s interest-bearing liabilities minus cash or cash equivalents, divided by its EBITDA. If a company has more cash than debt, the ratio can be negative.

The above chart shows a comparison of net debt-to-EBITDA for Merck & Co., as well as companies such as Pfizer (PFE), Bristol-Myers Squibb (BMY), Eli Lilly (LLY), and Novartis (NVS). Merck’s net debt-to-EBIDTA is 0.46x, which represents the company’s ability to handle its debt burden. Bristol-Myers Squibb’s cash and marketable securities are higher than its total debt, which leads to a negative net debt-to-EBITDA.

Total debt to equity

Total debt to equity is a measure of financial leverage, calculated as a company’s total debt liabilities, divided by its shareholders’ equity. Merck’s total debt-to-equity ratio is 43.87%. Among its peers, Eli Lilly’s debt-to-equity ratio is 52.35%, Bristol-Myers Squibb’s ratio is 52.27%, Pfizer’s debt-to-equity ratio is 51.22%, and Novartis’ debt-to-equity ratio is 28.77%. A lower total debt-to-equity ratio may enable Merck to obtain funds on competitive terms.

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Credit ratings and leverage

The leverage ratios determine the company’s ability to repay its debt, and they also directly affect the company’s credit rating. A company with a higher net debt-to-EBITDA ratio suggests that the company may not be able to service its debt in an appropriate manner, thereby lowering its credit rating and vice versa.

Merck and Co.’s long-term credit rating assigned by Standard & Poor’s is AA with a stable outlook. Its Moody’s Investors Services rating is A1 with a stable outlook. These ratings determine a company’s access to the capital markets and also offer flexibility in obtaining funds on competitive terms.

Details of debt

Merck and Co.’s loans payable as of December 31, 2014, include $1 billion of notes due in 2015, $1.5 billion of commercial paper, $55 million in short-term foreign borrowing, and $143 million of long-dated notes subject to repayment at the option of the holder. As of December 31, 2014, Merck’s total long-term debt is $18.7 billion.

MRK forms about 6.4% of the total assets held by the SPDR Health Care Select Sector SPDR ETF (XLV).

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