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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 Teradyne, Inc. (NASDAQ:TER) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Teradyne Carry?
The chart below, which you can click on for greater detail, shows that Teradyne had US$406.2m in debt in September 2020; about the same as the year before. But on the other hand it also has US$1.23b in cash, leading to a US$826.8m net cash position.
How Healthy Is Teradyne's Balance Sheet?
The latest balance sheet data shows that Teradyne had liabilities of US$671.8m due within a year, and liabilities of US$771.1m falling due after that. On the other hand, it had cash of US$1.23b and US$587.2m worth of receivables due within a year. So it actually has US$377.2m more liquid assets than total liabilities.
Having regard to Teradyne's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$19.3b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Teradyne boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Teradyne grew its EBIT by 72% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Teradyne can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept 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 produced sturdy free cash flow equating to 76% 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 Teradyne has US$826.8m in net cash and a decent-looking balance sheet. And we liked the look of last year's 72% year-on-year EBIT growth. So we don't think Teradyne's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Teradyne you should be aware of.
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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