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. We note that Balchem Corporation (NASDAQ:BCPC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Balchem's Debt?
As you can see below, at the end of June 2019, Balchem had US$230.3m of debt, up from US$210.8m a year ago. Click the image for more detail. However, because it has a cash reserve of US$41.7m, its net debt is less, at about US$188.6m.
A Look At Balchem's Liabilities
We can see from the most recent balance sheet that Balchem had liabilities of US$62.1m falling due within a year, and liabilities of US$303.9m due beyond that. On the other hand, it had cash of US$41.7m and US$101.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$222.7m.
Given Balchem has a market capitalization of US$3.23b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Balchem's net debt is only 1.2 times its EBITDA. And its EBIT covers its interest expense a whopping 16.4 times over. So we're pretty relaxed about its super-conservative use of debt. While Balchem doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Balchem can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Balchem generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Balchem's interest cover 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 conversion of EBIT to free cash flow also supports that impression! Zooming out, Balchem seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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 Balchem's earnings per share history for free.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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