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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies. Keysight Technologies, Inc. (NYSE:KEYS) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Keysight Technologies Carry?
The chart below, which you can click on for greater detail, shows that Keysight Technologies had US$1.79b in debt in April 2019; about the same as the year before. On the flip side, it has US$1.28b in cash leading to net debt of about US$515.0m.
A Look At Keysight Technologies’s Liabilities
According to the last reported balance sheet, Keysight Technologies had liabilities of US$1.49b due within 12 months, and liabilities of US$1.91b due beyond 12 months. Offsetting this, it had US$1.28b in cash and US$660.0m in receivables that were due within 12 months. So its liabilities total US$1.46b more than the combination of its cash and short-term receivables.
Since publicly traded Keysight Technologies shares are worth a very impressive total of US$17.2b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Because it carries more debt than cash, we think it’s worth watching Keysight Technologies’s balance sheet over time.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Keysight Technologies has net debt of just 0.56 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 9.67 times, which is more than adequate. Better yet, Keysight Technologies grew its EBIT by 145% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Keysight Technologies’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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Keysight Technologies recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
Keysight Technologies’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. And that’s just the beginning of the good news since its EBIT growth rate is also very heartening. Considering this range of factors, it seems to us that Keysight Technologies is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. We’d be very excited to see if Keysight Technologies insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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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If you spot an error that warrants correction, please contact the editor at email@example.com. 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.