Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We note that PerkinElmer, Inc. (NYSE: PKI) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow 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 October 2021, PerkinElmer was in debt of $ 5.10 billion, up from $ 1.85 billion a year ago. Click on the image for more details. On the other hand, it has $ 487.4 million in cash, resulting in net debt of around $ 4.62 billion.
Is PerkinElmer’s track record healthy?
We can see from the most recent balance sheet that PerkinElmer had liabilities of US $ 1.15 billion maturing within one year and liabilities of US $ 6.80 billion maturing beyond that. On the other hand, he had $ 487.4 million in cash and $ 947.8 million in receivables due within a year. It therefore has liabilities totaling US $ 6.51 billion more than its cash and short-term receivables combined.
This deficit is not that big as PerkinElmer is worth US $ 23.8 billion and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
PerkinElmer’s net debt to EBITDA ratio of around 2.4 suggests only moderate use of debt. And its imposing EBIT of 19.5 times its interest costs, means the debt burden is as light as a peacock feather. Notably, PerkinElmer’s EBIT was higher than Elon Musk’s, gaining a whopping 173% from last year. There is no doubt that we learn the most about debt from the balance sheet. But it’s future profits, more than anything, that will determine PerkinElmer’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 analyst earnings forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. 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 solid 84% of its EBIT, more than we expected. This positions it well to repay debt if it is desirable.
Our point of view
The good news is that PerkinElmer’s demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not end there, since its conversion of EBIT into free cash flow also confirms this impression! Looking at the big picture, we think PerkinElmer’s use of debt makes a lot of sense and we don’t care. After all, reasonable leverage can increase returns on equity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for PerkinElmer (1 of which is a bit unpleasant!) to know.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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