Is Analog Devices (NASDAQ:ADI) Using Too Much Debt?

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 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. As with many other companies Analog Devices, Inc. (NASDAQ:ADI) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Analog Devices

What Is Analog Devices's Net Debt?

As you can see below, at the end of May 2024, Analog Devices had US$8.12b of debt, up from US$6.73b a year ago. Click the image for more detail. However, it also had US$2.36b in cash, and so its net debt is US$5.76b.

A Look At Analog Devices' Liabilities

According to the last reported balance sheet, Analog Devices had liabilities of US$3.30b due within 12 months, and liabilities of US$10.3b due beyond 12 months. On the other hand, it had cash of US$2.36b and US$1.00b worth of receivables due within a year. So its liabilities total US$10.2b more than the combination of its cash and short-term receivables.

Since publicly traded Analog Devices shares are worth a very impressive total of US$114.4b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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

Analog Devices has a low net debt to EBITDA ratio of only 1.2. And its EBIT easily covers its interest expense, being 10.6 times the size. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Analog Devices's load is not too heavy, because its EBIT was down 39% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Analog Devices'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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Analog Devices actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Analog Devices's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its EBIT growth rate has the opposite effect. All these things considered, it appears that Analog Devices can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Analog Devices insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.