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. We note that Teradyne, Inc. (NASDAQ:TER) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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 Teradyne Carry?
As you can see below, Teradyne had US$387.2m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have US$895.3m in cash offsetting this, leading to net cash of US$508.1m.
How Healthy Is Teradyne's Balance Sheet?
We can see from the most recent balance sheet that Teradyne had liabilities of US$467.0m falling due within a year, and liabilities of US$725.1m due beyond that. Offsetting this, it had US$895.3m in cash and US$372.2m in receivables that were due within 12 months. So it can boast US$75.4m more liquid assets than total liabilities.
This state of affairs indicates that Teradyne's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$8.87b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Teradyne has more cash than debt is arguably a good indication that it can manage its debt safely.
The good news is that Teradyne has increased its EBIT by 8.5% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Teradyne'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 Teradyne 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. During the last three years, Teradyne generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case Teradyne has US$508m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in US$480m. So is Teradyne's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Teradyne would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
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.
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