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.' 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 Oxford Instruments plc (LON:OXIG) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Oxford Instruments's Debt?
The image below, which you can click on for greater detail, shows that at September 2021 Oxford Instruments had debt of UK£49.2m, up from UK£27.9m in one year. However, it does have UK£119.3m in cash offsetting this, leading to net cash of UK£70.1m.
A Look At Oxford Instruments' Liabilities
The latest balance sheet data shows that Oxford Instruments had liabilities of UK£204.8m due within a year, and liabilities of UK£17.9m falling due after that. Offsetting this, it had UK£119.3m in cash and UK£87.5m in receivables that were due within 12 months. So it has liabilities totalling UK£15.9m more than its cash and near-term receivables, combined.
Having regard to Oxford Instruments' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the UK£1.50b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Oxford Instruments also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, Oxford Instruments grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its debt. 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 Oxford Instruments 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, a company can only pay off debt with cold hard cash, not accounting profits. While Oxford Instruments has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Oxford Instruments generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Oxford Instruments has UK£70.1m in net cash. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in UK£27m. So is Oxford Instruments's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Oxford Instruments, you may well want to click here to check an interactive graph of its earnings per share history.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.