Ansell (ASX:ANN) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Ansell Limited (ASX:ANN) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Ansell

How Much Debt Does Ansell Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Ansell had US$737.7m of debt, an increase on US$422.6m, over one year. On the flip side, it has US$268.9m in cash leading to net debt of about US$468.8m.

A Look At Ansell's Liabilities

Zooming in on the latest balance sheet data, we can see that Ansell had liabilities of US$457.7m due within 12 months and liabilities of US$892.4m due beyond that. Offsetting this, it had US$268.9m in cash and US$204.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$876.4m.

This deficit isn't so bad because Ansell is worth US$3.43b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Ansell's net debt of 1.6 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.4 times interest expense) certainly does not do anything to dispel this impression. Also positive, Ansell grew its EBIT by 29% 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 Ansell can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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, Ansell generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Ansell's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! We would also note that Medical Equipment industry companies like Ansell commonly do use debt without problems. Considering this range of factors, it seems to us that Ansell is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Ansell is showing 2 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.