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.’ 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. We can see that Omnicell, Inc. (NASDAQ:OMCL) does use debt in its business. But should shareholders be worried about its use of debt?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Omnicell’s Debt?
As you can see below, at the end of September 2021, Omnicell had US$482.8m of debt, up from US$462.1m a year ago. Click the image for more detail. On the flip side, it has US$481.5m in cash leading to net debt of about US$1.27m.
How Strong Is Omnicell’s Balance Sheet?
We can see from the most recent balance sheet that Omnicell had liabilities of US$338.7m falling due within a year, and liabilities of US$601.5m due beyond that. On the other hand, it had cash of US$481.5m and US$244.3m worth of receivables due within a year. So its liabilities total US$214.3m more than the combination of its cash and short-term receivables.
Of course, Omnicell has a market capitalization of US$7.79b, 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. But either way, Omnicell has virtually no net debt, so it’s fair to say it does not have a heavy debt load!
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).
With net debt at just 0.0083 times EBITDA, it seems Omnicell only uses a little bit of leverage. Although with EBIT only covering interest expenses 4.3 times over, the company is truly paying for borrowing. Pleasingly, Omnicell is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 125% gain in the last twelve months. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Omnicell 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 last three years, Omnicell actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
The good news is that Omnicell’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But truth be told we feel its interest cover does undermine this impression a bit. It’s also worth noting that Omnicell is in the Healthcare Services industry, which is often considered to be quite defensive. It looks Omnicell has no trouble standing on its own two feet, and it has no reason to fear its lenders.