David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that UFP Technologies, Inc. (NASDAQ:UFPT) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for UFP Technologies
What Is UFP Technologies's Debt?
The image below, which you can click on for greater detail, shows that UFP Technologies had debt of US$55.0m at the end of December 2022, a reduction from US$75.2m over a year. However, it does have US$4.45m in cash offsetting this, leading to net debt of about US$50.5m.
How Strong Is UFP Technologies' Balance Sheet?
According to the last reported balance sheet, UFP Technologies had liabilities of US$56.0m due within 12 months, and liabilities of US$84.7m due beyond 12 months. Offsetting this, it had US$4.45m in cash and US$55.1m in receivables that were due within 12 months. So its liabilities total US$81.1m more than the combination of its cash and short-term receivables.
Given UFP Technologies has a market capitalization of US$1.01b, 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.
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).
UFP Technologies's net debt is only 0.90 times its EBITDA. And its EBIT covers its interest expense a whopping 17.2 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, UFP Technologies grew its EBIT by 106% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine UFP Technologies'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, UFP Technologies recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Our View
UFP Technologies'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 that's just the beginning of the good news since its EBIT growth rate is also very heartening. We would also note that Medical Equipment industry companies like UFP Technologies commonly do use debt without problems. Zooming out, UFP Technologies seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for UFP Technologies (of which 1 doesn't sit too well with us!) you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
About NasdaqCM:UFPT
UFP Technologies
Designs and manufactures solutions for medical devices, sterile packaging, and other highly engineered custom products.
Solid track record with moderate growth potential.