We Think Avanos Medical (NYSE:AVNS) Can Manage Its Debt With Ease

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Avanos Medical, Inc. (NYSE:AVNS) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Avanos Medical

How Much Debt Does Avanos Medical Carry?

The image below, which you can click on for greater detail, shows that Avanos Medical had debt of US$210.9m at the end of March 2023, a reduction from US$254.4m over a year. However, it also had US$95.7m in cash, and so its net debt is US$115.2m.

How Healthy Is Avanos Medical's Balance Sheet?

The latest balance sheet data shows that Avanos Medical had liabilities of US$158.5m due within a year, and liabilities of US$277.7m falling due after that. Offsetting this, it had US$95.7m in cash and US$142.7m in receivables that were due within 12 months. So its liabilities total US$197.8m more than the combination of its cash and short-term receivables.

Since publicly traded Avanos Medical shares are worth a total of US$1.16b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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).

Avanos Medical has net debt of just 0.88 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 7.8 times, which is more than adequate. Even more impressive was the fact that Avanos Medical grew its EBIT by 166% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Avanos Medical's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Avanos Medical recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Avanos Medical's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! It's also worth noting that Avanos Medical is in the Medical Equipment industry, which is often considered to be quite defensive. Considering this range of factors, it seems to us that Avanos Medical is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. Over time, share prices tend to follow earnings per share, so if you're interested in Avanos Medical, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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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.