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. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Mettler-Toledo International Inc. (NYSE:MTD) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Mettler-Toledo International Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Mettler-Toledo International had US$1.14b of debt, an increase on US$1.07b, over one year. However, it also had US$124.4m in cash, and so its net debt is US$1.02b.
A Look At Mettler-Toledo International's Liabilities
Zooming in on the latest balance sheet data, we can see that Mettler-Toledo International had liabilities of US$707.3m due within 12 months and liabilities of US$1.45b due beyond that. Offsetting these obligations, it had cash of US$124.4m as well as receivables valued at US$498.7m due within 12 months. So it has liabilities totalling US$1.53b more than its cash and near-term receivables, combined.
Given Mettler-Toledo International has a humongous market capitalization of US$16.9b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Mettler-Toledo International has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 19.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Mettler-Toledo International grew its EBIT by 8.6% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Mettler-Toledo International's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Mettler-Toledo International recorded free cash flow worth 62% 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.
Happily, Mettler-Toledo International's impressive interest cover implies it has the upper hand on its debt. And its conversion of EBIT to free cash flow is good too. When we consider the range of factors above, it looks like Mettler-Toledo International is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Mettler-Toledo International insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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.
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