Is Merit Medical Systems (NASDAQ:MMSI) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Merit Medical Systems, Inc. (NASDAQ:MMSI) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Merit Medical Systems

How Much Debt Does Merit Medical Systems Carry?

As you can see below, at the end of September 2024, Merit Medical Systems had US$750.5m of debt, up from US$286.1m a year ago. Click the image for more detail. However, it does have US$523.1m in cash offsetting this, leading to net debt of about US$227.4m.

How Strong Is Merit Medical Systems' Balance Sheet?

According to the last reported balance sheet, Merit Medical Systems had liabilities of US$201.1m due within 12 months, and liabilities of US$853.6m due beyond 12 months. On the other hand, it had cash of US$523.1m and US$213.3m worth of receivables due within a year. So its liabilities total US$318.2m more than the combination of its cash and short-term receivables.

Given Merit Medical Systems has a market capitalization of US$5.75b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Merit Medical Systems's net debt is only 0.91 times its EBITDA. And its EBIT covers its interest expense a whopping 31.8 times over. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that Merit Medical Systems has been able to increase its EBIT by 21% 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 ultimately the future profitability of the business will decide if Merit Medical Systems 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Merit Medical Systems generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Merit Medical Systems's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! We would also note that Medical Equipment industry companies like Merit Medical Systems commonly do use debt without problems. We think Merit Medical Systems is no more beholden to its lenders, than the birds are to birdwatchers. To our minds it has a healthy happy balance sheet. We'd be very excited to see if Merit Medical Systems insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.