These 4 Measures Indicate That Sonova Holding (VTX:SOON) Is Using Debt Reasonably Well

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Sonova Holding AG (VTX:SOON) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sonova Holding

How Much Debt Does Sonova Holding Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Sonova Holding had CHF1.58b of debt, an increase on CHF1.52b, over one year. However, it does have CHF263.1m in cash offsetting this, leading to net debt of about CHF1.32b.

How Healthy Is Sonova Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sonova Holding had liabilities of CHF1.07b due within 12 months and liabilities of CHF2.18b due beyond that. Offsetting these obligations, it had cash of CHF263.1m as well as receivables valued at CHF552.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF2.44b.

Given Sonova Holding has a humongous market capitalization of CHF15.3b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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

Sonova Holding's net debt to EBITDA ratio of about 1.5 suggests only moderate use of debt. And its commanding EBIT of 34.8 times its interest expense, implies the debt load is as light as a peacock feather. But the other side of the story is that Sonova Holding saw its EBIT decline by 4.1% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sonova Holding 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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Sonova Holding recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Sonova Holding's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its EBIT growth rate. It's also worth noting that Sonova Holding is in the Medical Equipment industry, which is often considered to be quite defensive. When we consider the range of factors above, it looks like Sonova Holding is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Sonova Holding that you should be aware of before investing here.

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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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.