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.' 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. Importantly, Nova Measuring Instruments Ltd. (NASDAQ:NVMI) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Nova Measuring Instruments's Net Debt?
As you can see below, at the end of December 2020, Nova Measuring Instruments had US$178.8m of debt, up from none a year ago. Click the image for more detail. However, it does have US$423.9m in cash offsetting this, leading to net cash of US$245.1m.
How Strong Is Nova Measuring Instruments' Balance Sheet?
According to the last reported balance sheet, Nova Measuring Instruments had liabilities of US$60.9m due within 12 months, and liabilities of US$223.3m due beyond 12 months. On the other hand, it had cash of US$423.9m and US$63.3m worth of receivables due within a year. So it can boast US$202.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Nova Measuring Instruments could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Nova Measuring Instruments has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Nova Measuring Instruments has boosted its EBIT by 52%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Nova Measuring Instruments'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. Nova Measuring Instruments 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, Nova Measuring Instruments produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Nova Measuring Instruments has US$245.1m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 52% over the last year. So is Nova Measuring Instruments'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. 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 Nova Measuring Instruments you should know about.
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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