Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Roper Technologies, Inc. (NYSE:ROP) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 Roper Technologies's Net Debt?
The image below, which you can click on for greater detail, shows that Roper Technologies had debt of US$4.72b at the end of June 2019, a reduction from US$5.62b over a year. However, it does have US$320.8m in cash offsetting this, leading to net debt of about US$4.40b.
A Look At Roper Technologies's Liabilities
According to the last reported balance sheet, Roper Technologies had liabilities of US$1.44b due within 12 months, and liabilities of US$6.11b due beyond 12 months. Offsetting this, it had US$320.8m in cash and US$939.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.30b.
Given Roper Technologies has a humongous market capitalization of US$35.9b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
With a debt to EBITDA ratio of 2.4, Roper Technologies uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 7.9 times its interest expenses harmonizes with that theme. If Roper Technologies can keep growing EBIT at last year's rate of 11% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Roper Technologies'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 always check how much of that EBIT is translated into free cash flow. Over the last three years, Roper Technologies recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
Roper Technologies's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And its interest cover is good too. When we consider the range of factors above, it looks like Roper Technologies is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. We'd be motivated to research the stock further if we found out that Roper Technologies insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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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