Is Novozymes (CPH:NZYM B) Using Too Much Debt?

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. As with many other companies Novozymes A/S (CPH:NZYM B) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Novozymes

What Is Novozymes's Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Novozymes had debt of kr.6.44b, up from kr.5.04b in one year. However, it does have kr.1.38b in cash offsetting this, leading to net debt of about kr.5.06b.

How Healthy Is Novozymes' Balance Sheet?

We can see from the most recent balance sheet that Novozymes had liabilities of kr.7.24b falling due within a year, and liabilities of kr.6.69b due beyond that. Offsetting this, it had kr.1.38b in cash and kr.4.08b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.8.48b.

Given Novozymes has a humongous market capitalization of kr.96.0b, 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 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.

Novozymes's net debt is only 0.92 times its EBITDA. And its EBIT covers its interest expense a whopping 50.9 times over. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Novozymes grew its EBIT by 6.7% in the last year, making that debt load look even more manageable. 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 Novozymes 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Novozymes produced sturdy free cash flow equating to 67% 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.

Our View

Novozymes's interest cover 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 conversion of EBIT to free cash flow also supports that impression! Zooming out, Novozymes seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Novozymes, 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.

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.