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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. 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. As with many other companies Meridian Bioscience, Inc. (NASDAQ:VIVO) makes use of debt. But should shareholders be worried about its use of debt?
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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Meridian Bioscience's Net Debt?
As you can see below, Meridian Bioscience had US$49.1m of debt, at March 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has US$49.6m in cash to offset that, meaning it has US$413.0k net cash.
How Strong Is Meridian Bioscience's Balance Sheet?
We can see from the most recent balance sheet that Meridian Bioscience had liabilities of US$37.9m falling due within a year, and liabilities of US$76.7m due beyond that. On the other hand, it had cash of US$49.6m and US$40.2m worth of receivables due within a year. So it has liabilities totalling US$24.8m more than its cash and near-term receivables, combined.
Since publicly traded Meridian Bioscience shares are worth a total of US$1.02b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Meridian Bioscience boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Meridian Bioscience if management cannot prevent a repeat of the 20% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Meridian Bioscience'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. Meridian Bioscience 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. Over the most recent three years, Meridian Bioscience recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Meridian Bioscience has US$413.0k in net cash. And it impressed us with free cash flow of US$27m, being 74% of its EBIT. So we don't have any problem with Meridian Bioscience's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Meridian Bioscience (1 doesn't sit too well with us) you should be aware of.
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.
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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