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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. 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 Novanta Inc. (NASDAQ:NOVT) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Novanta Carry?
You can click the graphic below for the historical numbers, but it shows that Novanta had US$214.6m of debt in June 2019, down from US$237.4m, one year before. On the flip side, it has US$66.1m in cash leading to net debt of about US$148.5m.
How Healthy Is Novanta's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Novanta had liabilities of US$98.5m due within 12 months and liabilities of US$298.6m due beyond that. Offsetting these obligations, it had cash of US$66.1m as well as receivables valued at US$88.8m due within 12 months. So its liabilities total US$242.3m more than the combination of its cash and short-term receivables.
Given Novanta has a market capitalization of US$2.98b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
With net debt sitting at just 1.3 times EBITDA, Novanta is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 8.6 times the interest expense over the last year. Novanta's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 Novanta'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Novanta recorded free cash flow worth 76% 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.
Novanta'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 the good news does not stop there, as its interest cover also supports that impression! Taking all this data into account, it seems to us that Novanta takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. We'd be motivated to research the stock further if we found out that Novanta insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.