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.' 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 IDEXX Laboratories, Inc. (NASDAQ:IDXX) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is IDEXX Laboratories's Net Debt?
As you can see below, IDEXX Laboratories had US$908.5m of debt at December 2020, down from US$987.7m a year prior. However, it also had US$383.9m in cash, and so its net debt is US$524.6m.
How Strong Is IDEXX Laboratories' Balance Sheet?
According to the last reported balance sheet, IDEXX Laboratories had liabilities of US$582.8m due within 12 months, and liabilities of US$1.08b due beyond 12 months. Offsetting these obligations, it had cash of US$383.9m as well as receivables valued at US$374.7m due within 12 months. So its liabilities total US$903.1m more than the combination of its cash and short-term receivables.
Of course, IDEXX Laboratories has a titanic market capitalization of US$41.5b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, IDEXX Laboratories has virtually no net debt, so it's fair to say it does not have a heavy debt load!
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
IDEXX Laboratories has a low net debt to EBITDA ratio of only 0.66. And its EBIT covers its interest expense a whopping 21.3 times over. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that IDEXX Laboratories has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine IDEXX Laboratories'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, IDEXX Laboratories recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
IDEXX Laboratories'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 EBIT growth rate also supports that impression! It's also worth noting that IDEXX Laboratories is in the Medical Equipment industry, which is often considered to be quite defensive. Considering this range of factors, it seems to us that IDEXX Laboratories is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for IDEXX Laboratories you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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IDEXX Laboratories, Inc. develops, manufactures, and distributes products and services primarily for the companion animal veterinary, livestock and poultry, dairy, and water testing markets worldwide.
Adequate balance sheet with moderate growth potential.