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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Novo Nordisk A/S (CPH:NOVO B) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Novo Nordisk's Debt?
As you can see below, at the end of June 2019, Novo Nordisk had ø4.23b of debt, up from ø247.0m a year ago. Click the image for more detail. However, it does have ø14.5b in cash offsetting this, leading to net cash of ø10.2b.
How Healthy Is Novo Nordisk's Balance Sheet?
The latest balance sheet data shows that Novo Nordisk had liabilities of ø56.6b due within a year, and liabilities of ø8.23b falling due after that. On the other hand, it had cash of ø14.5b and ø27.0b worth of receivables due within a year. 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 ø834.2b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Novo Nordisk also has more cash than debt, so we're pretty confident it can manage its debt safely.
The good news is that Novo Nordisk has increased its EBIT by 7.9% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Novo Nordisk can strengthen its balance sheet over time. 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. 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. Over the most recent three years, Novo Nordisk recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Novo Nordisk has ø10b in net cash. And it impressed us with free cash flow of ø31b, being 71% of its EBIT. So we don't think Novo Nordisk's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Novo Nordisk's earnings per share history for free.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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