Ansell (ASX:ANN) Has A Rock Solid Balance Sheet

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. As with many other companies Ansell Limited (ASX:ANN) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Ansell

What Is Ansell's Debt?

You can click the graphic below for the historical numbers, but it shows that Ansell had US$522.6m of debt in December 2020, down from US$579.5m, one year before. However, it does have US$350.0m in cash offsetting this, leading to net debt of about US$172.6m.

How Healthy Is Ansell's Balance Sheet?

We can see from the most recent balance sheet that Ansell had liabilities of US$454.2m falling due within a year, and liabilities of US$648.5m due beyond that. On the other hand, it had cash of US$350.0m and US$235.4m worth of receivables due within a year. So its liabilities total US$517.3m more than the combination of its cash and short-term receivables.

Since publicly traded Ansell shares are worth a total of US$4.18b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Ansell has a low net debt to EBITDA ratio of only 0.56. And its EBIT covers its interest expense a whopping 16.6 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Ansell has boosted its EBIT by 32%, thus reducing the spectre of future debt repayments. 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 Ansell's ability to maintain a healthy balance sheet going forward. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Ansell recorded free cash flow worth 69% 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.

Our View

Happily, Ansell's impressive interest cover implies it has the upper hand on its debt. 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. We'd be very excited to see if Ansell insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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