David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, Nordson Corporation (NASDAQ:NDSN) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Nordson’s Debt?
You can click the graphic below for the historical numbers, but it shows that Nordson had US$1.34b of debt in July 2019, down from US$1.56b, one year before. However, it also had US$147.8m in cash, and so its net debt is US$1.19b.
How Healthy Is Nordson’s Balance Sheet?
According to the last reported balance sheet, Nordson had liabilities of US$444.2m due within 12 months, and liabilities of US$1.50b due beyond 12 months. Offsetting this, it had US$147.8m in cash and US$495.7m in receivables that were due within 12 months. So it has liabilities totalling US$1.30b more than its cash and near-term receivables, combined.
Since publicly traded Nordson shares are worth a total of US$7.95b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Nordson’s net debt of 2.1 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.8 times interest expense) certainly does not do anything to dispel this impression. Unfortunately, Nordson saw its EBIT slide 8.6% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Nordson’s ability to maintain a healthy balance sheet going forward. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Nordson produced sturdy free cash flow equating to 71% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Both Nordson’s ability to to convert EBIT to free cash flow and its interest cover gave us comfort that it can handle its debt. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. Considering this range of data points, we think Nordson is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Of course, we wouldn’t say no to the extra confidence that we’d gain if we knew that Nordson insiders have been buying shares: if you’re on the same wavelength, you can find out if insiders are buying by clicking this link.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.