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. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Mostly, Sonova Holding AG (VTX: SOON) is in debt. But does this debt worry shareholders?
Why is debt risky?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest analysis for Sonova Holding
What is Sonova Holding’s debt?
The graph below, which you can click on for more details, shows that Sonova Holding had a debt of 1.59 billion francs in September 2021; about the same as the previous year. On the other hand, it has 1.53 billion francs in cash, which results in a net debt of approximately 63.4 million francs.
How strong is Sonova Holding’s balance sheet?
According to the last published balance sheet, Sonova Holding had liabilities of 1.62 billion francs maturing within 12 months and liabilities of 1.55 billion francs maturing beyond 12 months. In compensation for these obligations, it had cash of 1.53 billion francs as well as receivables valued at 451.5 million francs due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of CHF 1.19 billion.
Given that Sonova Holding has a colossal market capitalization of 20.2 billion francs, it is hard to believe that these liabilities pose a threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate. But either way, Sonova Holding has virtually no net debt, so it’s fair to say it’s not heavily leveraged!
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Sonova Holding has very little debt (net of cash) and has a debt/EBITDA ratio of 0.07 and an EBIT of 31.1 times interest expense. Indeed, relative to its earnings, its leverage seems light as a feather. On top of that, we are pleased to report that Sonova Holding increased its EBIT by 87%, reducing the specter of future debt repayments. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Sonova Holding can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Fortunately for all shareholders, Sonova Holding has actually produced more free cash flow than EBIT for the past three years. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
The good news is that Sonova Holding’s demonstrated ability to cover its interest charges with its EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. It should also be noted that Sonova Holding is in the medical equipment industry, which is often seen as quite defensive. We believe that Sonova Holding is no more beholden to its lenders than birds are to bird watchers. For investment nerds like us, his track record is almost charming. Over time, stock prices tend to track earnings per share, so if you’re interested in Sonova Holding, you may want to click here to view an interactive chart of its earnings per share history.
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.
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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.