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David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ 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. Like many other companies ResMed Inc. (NYSE: RMD) uses debt. But does this debt worry shareholders?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest review for ResMed
How much debt does ResMed have?
The image below, which you can click for more details, shows ResMed owed $ 805.7 million in debt at the end of September 2021, a reduction from $ 1.06 billion. over a year. However, he also had $ 309.3 million in cash, so his net debt is $ 496.4 million.
How strong is ResMed’s balance sheet?
Zooming in on the latest balance sheet data, we can see that ResMed had a liability of US $ 624.2 million due within 12 months and a liability of US $ 1.08 billion beyond. In compensation for these obligations, he had cash of US $ 309.3 million as well as receivables valued at US $ 601.4 million due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 792.5 million.
Of course, ResMed has a titanic market cap of $ 38.1 billion, so those liabilities are likely manageable. Having said that, it is clear that we must continue to monitor his record lest it get worse. But in any case, ResMed has virtually no net debt, so it’s fair to say that it doesn’t have a lot of debt!
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 earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt compared to EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
ResMed’s net debt is only 0.46 times its EBITDA. And its EBIT easily covers its interest costs, which is 43.2 times the size. So we’re pretty relaxed about its ultra-conservative use of debt. And we also warmly note that ResMed increased its EBIT by 13% last year, which makes its debt more manageable. The balance sheet is clearly the area to focus on when analyzing debt. But it is future profits, more than anything, that will determine ResMed’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, ResMed has generated strong free cash flow equivalent to 63% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
ResMed’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news does not end there, since its net debt to EBITDA also supports this impression! We would also like to note that companies in the medical device industry like ResMed generally use debt with no problem. Looking at the big picture, we think ResMed’s use of debt looks very reasonable and we don’t care. After all, reasonable leverage can increase returns on equity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for ResMed you should know.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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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 any stock 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 any of the stocks mentioned.
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