Yahoo Finance We Think Analog Devices (NASDAQ:ADI) Can Stay On Top Of Its Debt
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Analog Devices, Inc. (NASDAQ:ADI) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Analog Devices
What Is Analog Devices's Debt?
You can click the graphic below for the historical numbers, but it shows that as of May 2024 Analog Devices had US$8.12b of debt, an increase on US$6.73b, over one year. However, because it has a cash reserve of US$2.36b, its net debt is less, at about US$5.76b.
How Healthy Is Analog Devices' Balance Sheet?
The latest balance sheet data shows that Analog Devices had liabilities of US$3.30b due within a year, and liabilities of US$10.3b falling due after that. Offsetting this, it had US$2.36b in cash and US$1.00b in receivables that were due within 12 months. So it has liabilities totalling US$10.2b more than its cash and near-term receivables, combined.
Since publicly traded Analog Devices shares are worth a very impressive total of US$116.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Analog Devices's net debt is only 1.2 times its EBITDA. And its EBIT covers its interest expense a whopping 10.6 times over. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Analog Devices if management cannot prevent a repeat of the 39% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Analog Devices'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Analog Devices actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our View
Happily, Analog Devices's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But the stark truth is that we are concerned by its EBIT growth rate. Looking at all the aforementioned factors together, it strikes us that Analog Devices can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Analog Devices insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
