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Is Kewaunee Scientific (NASDAQ:KEQU) A Risky Investment?

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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.' 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. We note that Kewaunee Scientific Corporation (NASDAQ:KEQU) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Kewaunee Scientific

What Is Kewaunee Scientific's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of April 2019 Kewaunee Scientific had US$10.9m of debt, an increase on US$6.32m, over one year. However, it does have US$10.6m in cash offsetting this, leading to net debt of about US$279.0k.

NasdaqGM:KEQU Historical Debt, August 2nd 2019
NasdaqGM:KEQU Historical Debt, August 2nd 2019

How Healthy Is Kewaunee Scientific's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kewaunee Scientific had liabilities of US$32.7m due within 12 months and liabilities of US$6.79m due beyond that. Offsetting these obligations, it had cash of US$10.6m as well as receivables valued at US$33.3m due within 12 months. So it actually has US$4.39m more liquid assets than total liabilities.

This short term liquidity is a sign that Kewaunee Scientific could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, Kewaunee Scientific has a very light debt load indeed.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt at just 0.057 times EBITDA, it seems Kewaunee Scientific only uses a little bit of leverage. But EBIT was only 6.3 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. In fact Kewaunee Scientific's saving grace is its low debt levels, because its EBIT has tanked 75% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Kewaunee Scientific'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, 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. In the last three years, Kewaunee Scientific's free cash flow amounted to 39% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Kewaunee Scientific's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better In particular, we thought its net debt to EBITDA was a positive. We would also note that Medical Equipment industry companies like Kewaunee Scientific commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Kewaunee Scientific's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. Given Kewaunee Scientific has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.