Teradyne (NASDAQ:TER) Seems To Use Debt Quite Sensibly

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.' 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. Importantly, Teradyne, Inc. (NASDAQ:TER) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Teradyne

How Much Debt Does Teradyne Carry?

You can click the graphic below for the historical numbers, but it shows that Teradyne had US$64.8m of debt in October 2022, down from US$145.0m, one year before. But it also has US$776.1m in cash to offset that, meaning it has US$711.3m net cash.

A Look At Teradyne's Liabilities

The latest balance sheet data shows that Teradyne had liabilities of US$701.9m due within a year, and liabilities of US$363.8m falling due after that. Offsetting these obligations, it had cash of US$776.1m as well as receivables valued at US$530.3m due within 12 months. So it actually has US$240.6m more liquid assets than total liabilities.

This state of affairs indicates that Teradyne's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$13.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Teradyne has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Teradyne's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Teradyne can strengthen its balance sheet over time. 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. While Teradyne has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Teradyne recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Teradyne has US$711.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$568m, being 71% of its EBIT. So we don't have any problem with Teradyne's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Teradyne's earnings per share history for free.

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.

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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.