Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Fisher & Paykel Healthcare Corporation Limited (NZSE:FPH) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Fisher & Paykel Healthcare Carry?
You can click the graphic below for the historical numbers, but it shows that Fisher & Paykel Healthcare had NZ$72.3m of debt in September 2021, down from NZ$80.2m, one year before. But on the other hand it also has NZ$288.4m in cash, leading to a NZ$216.1m net cash position.
How Strong Is Fisher & Paykel Healthcare's Balance Sheet?
According to the last reported balance sheet, Fisher & Paykel Healthcare had liabilities of NZ$314.3m due within 12 months, and liabilities of NZ$140.3m due beyond 12 months. Offsetting these obligations, it had cash of NZ$288.4m as well as receivables valued at NZ$248.6m due within 12 months. So it actually has NZ$82.4m more liquid assets than total liabilities.
This state of affairs indicates that Fisher & Paykel Healthcare's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NZ$18.6b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Fisher & Paykel Healthcare has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Fisher & Paykel Healthcare has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Fisher & Paykel Healthcare's ability to maintain a healthy balance sheet going forward. 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. While Fisher & Paykel Healthcare 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. Looking at the most recent three years, Fisher & Paykel Healthcare recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While we empathize with investors who find debt concerning, you should keep in mind that Fisher & Paykel Healthcare has net cash of NZ$216.1m, as well as more liquid assets than liabilities. And we liked the look of last year's 35% year-on-year EBIT growth. So we don't think Fisher & Paykel Healthcare's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Fisher & Paykel Healthcare's earnings per share history for free.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.