Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Edwards Lifesciences Corporation (NYSE:EW) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Edwards Lifesciences's Net Debt?
As you can see below, Edwards Lifesciences had US$595.5m of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has US$1.79b in cash to offset that, meaning it has US$1.20b net cash.
How Strong Is Edwards Lifesciences' Balance Sheet?
We can see from the most recent balance sheet that Edwards Lifesciences had liabilities of US$966.5m falling due within a year, and liabilities of US$1.65b due beyond that. Offsetting these obligations, it had cash of US$1.79b as well as receivables valued at US$664.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$160.1m.
Having regard to Edwards Lifesciences' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$72.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Edwards Lifesciences also has more cash than debt, so we're pretty confident it can manage its debt safely.
Also positive, Edwards Lifesciences grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Edwards Lifesciences can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Edwards Lifesciences has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Edwards Lifesciences recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Edwards Lifesciences has US$1.20b in net cash. And it impressed us with its EBIT growth of 21% over the last year. So we don't think Edwards Lifesciences's use of debt is risky. Another factor that would give us confidence in Edwards Lifesciences would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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