Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that ICON Public Limited Company (NASDAQ:ICLR) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is ICON's Net Debt?
The chart below, which you can click on for greater detail, shows that ICON had US$350.0m in debt in June 2021; about the same as the year before. But on the other hand it also has US$1.06b in cash, leading to a US$707.2m net cash position.
How Strong Is ICON's Balance Sheet?
We can see from the most recent balance sheet that ICON had liabilities of US$1.11b falling due within a year, and liabilities of US$451.5m due beyond that. Offsetting these obligations, it had cash of US$1.06b as well as receivables valued at US$1.16b due within 12 months. So it can boast US$657.7m more liquid assets than total liabilities.
This short term liquidity is a sign that ICON could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, ICON boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, ICON grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. 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 ICON 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. ICON may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, ICON generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case ICON has US$707.2m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in US$496m. So is ICON's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with ICON .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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.
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