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Novo Nordisk (CPH:NOVO B) Could Easily Take On More Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk'. 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 Novo Nordisk A/S (CPH:NOVO B) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

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Check out our latest analysis for Novo Nordisk

What Is Novo Nordisk's Debt?

The image below, which you can click on for greater detail, shows that at December 2019 Novo Nordisk had debt of ø659.0m, up from ø515.0m in one year. But it also has ø15.5b in cash to offset that, meaning it has ø14.8b net cash.

CPSE:NOVO B Historical Debt April 26th 2020
CPSE:NOVO B Historical Debt April 26th 2020

How Healthy Is Novo Nordisk's Balance Sheet?

We can see from the most recent balance sheet that Novo Nordisk had liabilities of ø59.0b falling due within a year, and liabilities of ø9.04b due beyond that. Offsetting this, it had ø15.5b in cash and ø29.2b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ø23.4b.

Of course, Novo Nordisk has a titanic market capitalization of ø1.05t, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Novo Nordisk boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Novo Nordisk grew its EBIT by 13% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Novo Nordisk's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Novo Nordisk has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Novo Nordisk produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Novo Nordisk has ø14.8b in net cash. And it impressed us with free cash flow of ø36b, being 67% of its EBIT. So we don't think Novo Nordisk's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Novo Nordisk you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.