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 can see that Coherent, Inc. (NASDAQ:COHR) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Coherent's Debt?
As you can see below, at the end of June 2019, Coherent had US$454.5m of debt, up from US$429.4m a year ago. Click the image for more detail. However, it also had US$318.6m in cash, and so its net debt is US$135.9m.
A Look At Coherent's Liabilities
We can see from the most recent balance sheet that Coherent had liabilities of US$288.5m falling due within a year, and liabilities of US$546.9m due beyond that. On the other hand, it had cash of US$318.6m and US$281.1m worth of receivables due within a year. So it has liabilities totalling US$235.7m more than its cash and near-term receivables, combined.
Given Coherent has a market capitalization of US$3.77b, 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.
Coherent has net debt of just 0.49 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.6 times, which is more than adequate. In fact Coherent's saving grace is its low debt levels, because its EBIT has tanked 66% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Coherent's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Coherent produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Coherent's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better There's no doubt that its ability handle its debt, based on its EBITDA, is pretty flash. When we consider all the elements mentioned above, it seems to us that Coherent is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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 Coherent's earnings per share history for free.
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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