Here's Why Waters (NYSE:WAT) Can Manage Its Debt Responsibly

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 Waters Corporation (NYSE:WAT) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Waters

What Is Waters's Net Debt?

As you can see below, Waters had US$1.58b of debt, at December 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$481.4m in cash offsetting this, leading to net debt of about US$1.10b.

How Healthy Is Waters' Balance Sheet?

We can see from the most recent balance sheet that Waters had liabilities of US$785.7m falling due within a year, and liabilities of US$1.99b due beyond that. Offsetting these obligations, it had cash of US$481.4m as well as receivables valued at US$722.9m due within 12 months. So it has liabilities totalling US$1.57b more than its cash and near-term receivables, combined.

Of course, Waters has a titanic market capitalization of US$17.7b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Waters has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 23.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Waters grew its EBIT by 6.9% 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 it is future earnings, more than anything, that will determine Waters'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Waters produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Waters's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Waters's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Waters that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.