Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Edwards Lifesciences Corporation (NYSE:EW) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Edwards Lifesciences's Net Debt?
As you can see below, Edwards Lifesciences had US$594.1m of debt at June 2019, down from US$1.19b a year prior. However, it does have US$934.3m in cash offsetting this, leading to net cash of US$340.2m.
A Look At Edwards Lifesciences's Liabilities
According to the last reported balance sheet, Edwards Lifesciences had liabilities of US$697.0m due within 12 months, and liabilities of US$1.38b due beyond 12 months. On the other hand, it had cash of US$934.3m and US$609.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$529.3m.
This state of affairs indicates that Edwards Lifesciences's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$47.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Edwards Lifesciences boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Edwards Lifesciences grew its EBIT by 16% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Edwards Lifesciences 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Edwards Lifesciences 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, Edwards Lifesciences recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Edwards Lifesciences has US$340m in net cash. So is Edwards Lifesciences's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Edwards Lifesciences 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.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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