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. Importantly, Insulet Corporation (NASDAQ:PODD) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Insulet Carry?
As you can see below, at the end of December 2020, Insulet had US$1.06b of debt, up from US$887.9m a year ago. Click the image for more detail. However, it also had US$947.6m in cash, and so its net debt is US$111.7m.
A Look At Insulet's Liabilities
Zooming in on the latest balance sheet data, we can see that Insulet had liabilities of US$207.8m due within 12 months and liabilities of US$1.06b due beyond that. On the other hand, it had cash of US$947.6m and US$83.8m worth of receivables due within a year. So it has liabilities totalling US$237.9m more than its cash and near-term receivables, combined.
Having regard to Insulet's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$17.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Insulet has a very light debt load indeed.
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). 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).
Given net debt is only 1.0 times EBITDA, it is initially surprising to see that Insulet's EBIT has low interest coverage of 1.1 times. So one way or the other, it's clear the debt levels are not trivial. Insulet grew its EBIT by 3.0% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to 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 Insulet 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. Over the last three years, Insulet saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Both Insulet's conversion of EBIT to free cash flow and its interest cover were discouraging. At least its net debt to EBITDA gives us reason to be optimistic. We should also note that Medical Equipment industry companies like Insulet commonly do use debt without problems. We think that Insulet's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Insulet (including 1 which is significant) .
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.
When trading Insulet or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted
Valuation is complex, but we're helping make it simple.
Find out whether Insulet is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.