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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.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies. Teradyne, Inc. (NASDAQ:TER) makes use of debt. But the real question is whether this debt is making the company risky.
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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Teradyne’s Net Debt?
As you can see below, Teradyne had US$383.6m of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. But on the other hand it also has US$904.8m in cash, leading to a US$521.2m net cash position.
A Look At Teradyne’s Liabilities
We can see from the most recent balance sheet that Teradyne had liabilities of US$442.0m falling due within a year, and liabilities of US$704.4m due beyond that. Offsetting this, it had US$904.8m in cash and US$333.8m in receivables that were due within 12 months. So it actually has US$92.2m more liquid assets than total liabilities.
Having regard to Teradyne’s size, it seems that its liquid assets are well balanced with its total liabilities. So it’s very unlikely that the US$7.94b company is short on cash, but still worth keeping an eye on the balance sheet. Given that Teradyne has more cash than debt, we’re pretty confident it can manage its debt safely.
But the other side of the story is that Teradyne saw its EBIT decline by 9.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Teradyne’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.
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. During the last three years, Teradyne generated free cash flow amounting to a very robust 90% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Teradyne has net cash of US$521m, as well as more liquid assets than liabilities. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in US$472m. So we don’t think Teradyne’s use of debt is risky. Of course, we wouldn’t say no to the extra confidence that we’d gain if we knew that Teradyne insiders have been buying shares: if you’re on the same wavelength, you can find out if insiders are buying by clicking this link.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.