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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Edwards Lifesciences Corporation (NYSE:EW) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
How Much Debt Does Edwards Lifesciences Carry?
As you can see below, Edwards Lifesciences had US$595.2m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$1.33b in cash, so it actually has US$735.4m net cash.
How Healthy Is Edwards Lifesciences' Balance Sheet?
We can see from the most recent balance sheet that Edwards Lifesciences had liabilities of US$799.0m falling due within a year, and liabilities of US$1.76b due beyond that. On the other hand, it had cash of US$1.33b and US$664.3m worth of receivables due within a year. So its liabilities total US$560.4m more than the combination of its cash and short-term receivables.
This state of affairs indicates that Edwards Lifesciences' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$55.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Edwards Lifesciences boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that Edwards Lifesciences has increased its EBIT by 2.6% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Edwards Lifesciences 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. Edwards Lifesciences 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, Edwards Lifesciences produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
We could understand if investors are concerned about Edwards Lifesciences's liabilities, but we can be reassured by the fact it has has net cash of US$735.4m. So is Edwards Lifesciences's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Edwards Lifesciences .
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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