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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Quidel Corporation (NASDAQ:QDEL) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Quidel's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Quidel had US$6.70m of debt in September 2020, down from US$20.7m, one year before. However, its balance sheet shows it holds US$77.5m in cash, so it actually has US$70.9m net cash.
How Healthy Is Quidel's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Quidel had liabilities of US$207.9m due within 12 months and liabilities of US$192.2m due beyond that. On the other hand, it had cash of US$77.5m and US$376.1m worth of receivables due within a year. So it can boast US$53.6m more liquid assets than total liabilities.
Having regard to Quidel's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$7.97b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Quidel boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, Quidel grew its EBIT by 396% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Quidel'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. Quidel 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, Quidel produced sturdy free cash flow equating to 54% 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.
While it is always sensible to investigate a company's debt, in this case Quidel has US$70.9m in net cash and a decent-looking balance sheet. And we liked the look of last year's 396% year-on-year EBIT growth. So we don't think Quidel's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Quidel (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.
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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