Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that PerkinElmer, Inc. (NYSE:PKI) has debt on its balance sheet. But does this debt worry shareholders?
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for PerkinElmer
What is PerkinElmer’s net debt?
As you can see below, at the end of January 2022, PerkinElmer had $4.98 billion in debt, up from $1.99 billion a year ago. Click on the image for more details. However, he also had $618.3 million in cash, so his net debt is $4.37 billion.
How strong is PerkinElmer’s balance sheet?
Zooming in on the latest balance sheet data, we can see that PerkinElmer had liabilities of US$1.23 billion due within 12 months and liabilities of US$6.65 billion due beyond. In return, he had $618.3 million in cash and $1.02 billion in receivables due within 12 months. It therefore has liabilities totaling $6.24 billion more than its cash and short-term receivables, combined.
PerkinElmer has a very large market capitalization of $22.6 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
PerkinElmer’s net debt to EBITDA ratio of around 2.4 suggests only moderate use of debt. And its strong interest coverage of 14.8 times makes us even more comfortable. Importantly, PerkinElmer has grown its EBIT by 51% over the last twelve months, and this growth will make it easier to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine PerkinElmer’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, PerkinElmer has generated free cash flow of a very strong 84% of EBIT, more than we expected. This positions him well to pay off debt if desired.
Our point of view
Fortunately, PerkinElmer’s impressive interest coverage means it has the upper hand on its debt. And the good news does not stop there, since its conversion of EBIT into free cash flow also confirms this impression! Zooming out, PerkinElmer appears to be using debt quite sensibly; and that gets the green light from us. After all, reasonable leverage can increase return on equity. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 3 warning signs for PerkinElmer you should be aware, and one of them is concerning.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.