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. We can see that Indivior PLC (LON:INDV) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.
What Is Indivior's Net Debt?
As you can see below, Indivior had US$239.0m of debt at June 2019, down from US$477.0m a year prior. But it also has US$988.0m in cash to offset that, meaning it has US$749.0m net cash.
How Strong Is Indivior's Balance Sheet?
We can see from the most recent balance sheet that Indivior had liabilities of US$645.0m falling due within a year, and liabilities of US$718.0m due beyond that. Offsetting this, it had US$988.0m in cash and US$214.0m in receivables that were due within 12 months. So its liabilities total US$161.0m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Indivior is worth US$532.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Indivior also has more cash than debt, so we're pretty confident it can manage its debt safely.
Better yet, Indivior grew its EBIT by 173% 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 Indivior'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. Indivior 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, Indivior generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Although Indivior's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$749m. And it impressed us with free cash flow of US$281m, being 98% of its EBIT. So we don't think Indivior's use of debt is risky. Another factor that would give us confidence in Indivior would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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