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. As with many other companies Integra LifeSciences Holdings Corporation (NASDAQ:IART) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does Integra LifeSciences Holdings Carry?
As you can see below, Integra LifeSciences Holdings had US$1.61b of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has US$397.4m in cash leading to net debt of about US$1.21b.
A Look At Integra LifeSciences Holdings’ Liabilities
Zooming in on the latest balance sheet data, we can see that Integra LifeSciences Holdings had liabilities of US$318.8m due within 12 months and liabilities of US$1.82b due beyond that. Offsetting these obligations, it had cash of US$397.4m as well as receivables valued at US$237.8m due within 12 months. So its liabilities total US$1.50b more than the combination of its cash and short-term receivables.
This deficit isn’t so bad because Integra LifeSciences Holdings is worth US$6.42b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Integra LifeSciences Holdings has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 5.0 times. Taken together this implies that, while we wouldn’t want to see debt levels rise, we think it can handle its current leverage. It is well worth noting that Integra LifeSciences Holdings’s EBIT shot up like bamboo after rain, gaining 41% in the last twelve months. That’ll make it easier to manage its debt. 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 Integra LifeSciences Holdings can strengthen its balance sheet over time.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Integra LifeSciences Holdings recorded free cash flow worth 63% 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.
Our View
Happily, Integra LifeSciences Holdings’s impressive EBIT growth rate implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. We would also note that Medical Equipment industry companies like Integra LifeSciences Holdings commonly do use debt without problems. Taking all this data into account, it seems to us that Integra LifeSciences Holdings takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start.