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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that ICON Public Limited Company (NASDAQ:ICLR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 ICON Carry?
The chart below, which you can click on for greater detail, shows that ICON had US$349.9m in debt in September 2020; about the same as the year before. But it also has US$709.7m in cash to offset that, meaning it has US$359.8m net cash.
How Strong Is ICON's Balance Sheet?
The latest balance sheet data shows that ICON had liabilities of US$1.24b due within a year, and liabilities of US$111.1m falling due after that. Offsetting these obligations, it had cash of US$709.7m as well as receivables valued at US$1.02b due within 12 months. So it actually has US$373.9m more liquid assets than total liabilities.
This short term liquidity is a sign that ICON could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that ICON has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, ICON saw its EBIT drop by 3.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 ICON'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While ICON has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, ICON recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case ICON has US$359.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in US$460m. So is ICON's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in ICON, you may well want to click here to check an interactive graph of its earnings per share history.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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