These 4 Measures Indicate That Merit Medical Systems (NASDAQ:MMSI) Is Using Debt Safely

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 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. Importantly, Merit Medical Systems, Inc. (NASDAQ:MMSI) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Merit Medical Systems

What Is Merit Medical Systems's Debt?

As you can see below, at the end of September 2023, Merit Medical Systems had US$286.1m of debt, up from US$216.7m a year ago. Click the image for more detail. However, it does have US$61.0m in cash offsetting this, leading to net debt of about US$225.1m.

How Healthy Is Merit Medical Systems' Balance Sheet?

According to the last reported balance sheet, Merit Medical Systems had liabilities of US$187.1m due within 12 months, and liabilities of US$391.5m due beyond 12 months. Offsetting this, it had US$61.0m in cash and US$190.8m in receivables that were due within 12 months. So it has liabilities totalling US$326.8m more than its cash and near-term receivables, combined.

Since publicly traded Merit Medical Systems shares are worth a total of US$4.12b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Merit Medical Systems has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 10.5 times over. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Merit Medical Systems grew its EBIT by 4.8% in the last year, making that debt load look even more manageable. 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 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Merit Medical Systems recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Merit Medical Systems's conversion of EBIT to free cash flow 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 interest cover also supports that impression! It's also worth noting that Merit Medical Systems is in the Medical Equipment industry, which is often considered to be quite defensive. Zooming out, Merit Medical Systems seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Another factor that would give us confidence in Merit Medical Systems would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.