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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that IDEXX Laboratories, Inc. (NASDAQ:IDXX) does use debt in its business. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.
What Is IDEXX Laboratories's Debt?
The image below, which you can click on for greater detail, shows that IDEXX Laboratories had debt of US$905.1m at the end of June 2021, a reduction from US$1.02b over a year. However, it does have US$232.1m in cash offsetting this, leading to net debt of about US$672.9m.
A Look At IDEXX Laboratories' Liabilities
According to the last reported balance sheet, IDEXX Laboratories had liabilities of US$651.8m due within 12 months, and liabilities of US$1.01b due beyond 12 months. On the other hand, it had cash of US$232.1m and US$427.4m worth of receivables due within a year. So its liabilities total US$1.00b more than the combination of its cash and short-term receivables.
This state of affairs indicates that IDEXX Laboratories' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$54.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, IDEXX Laboratories has virtually no net debt, so it's fair to say it does not have a heavy debt load!
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). 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 0.70. And its EBIT easily covers its interest expense, being 28.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, IDEXX Laboratories grew its EBIT by 42% 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 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, IDEXX Laboratories 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.
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. We think IDEXX Laboratories is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that IDEXX Laboratories is showing 2 warning signs in our investment analysis , you should know about...
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.
What are the risks and opportunities for IDEXX Laboratories?
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.
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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.