Why Merck’s Leverage is Important to Investors

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.

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 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.

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.

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).