Sonova Holding (VTX:SOON) 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. Importantly, Sonova Holding AG (VTX:SOON) does carry debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Sonova Holding

How Much Debt Does Sonova Holding Carry?

The chart below, which you can click on for greater detail, shows that Sonova Holding had CHF1.59b in debt in September 2021; about the same as the year before. On the flip side, it has CHF1.53b in cash leading to net debt of about CHF63.4m.

How Strong Is Sonova Holding's Balance Sheet?

According to the last reported balance sheet, Sonova Holding had liabilities of CHF1.62b due within 12 months, and liabilities of CHF1.55b due beyond 12 months. Offsetting these obligations, it had cash of CHF1.53b as well as receivables valued at CHF451.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF1.19b.

Given Sonova Holding has a humongous market capitalization of CHF20.2b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Sonova Holding has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sonova Holding has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.07 and EBIT of 31.1 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. In addition to that, we're happy to report that Sonova Holding has boosted its EBIT by 87%, thus reducing the spectre of future debt repayments. 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 Sonova Holding 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, 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. Happily for any shareholders, Sonova Holding actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that Sonova Holding's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. It's also worth noting that Sonova Holding is in the Medical Equipment industry, which is often considered to be quite defensive. We think Sonova Holding is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming. Over time, share prices tend to follow earnings per share, so if you're interested in Sonova Holding, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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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.