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 Zebra Technologies Corporation (NASDAQ:ZBRA) 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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does Zebra Technologies Carry?
The image below, which you can click on for greater detail, shows that Zebra Technologies had debt of US$1.09b at the end of April 2021, a reduction from US$1.45b over a year. However, it does have US$177.0m in cash offsetting this, leading to net debt of about US$917.0m.
How Healthy Is Zebra Technologies’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Zebra Technologies had liabilities of US$1.55b due within 12 months and liabilities of US$1.45b due beyond that. On the other hand, it had cash of US$177.0m and US$528.0m worth of receivables due within a year. So it has liabilities totalling US$2.30b more than its cash and near-term receivables, combined.
Since publicly traded Zebra Technologies shares are worth a very impressive total of US$29.2b, 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.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Zebra Technologies has a low net debt to EBITDA ratio of only 0.96. And its EBIT easily covers its interest expense, being 27.7 times the size. So we’re pretty relaxed about its super-conservative use of debt. And we also note warmly that Zebra Technologies grew its EBIT by 12% last year, making its debt load easier to handle. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Zebra Technologies’s ability to maintain a healthy balance sheet going forward.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Zebra Technologies actually produced more free cash flow than EBIT. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
Zebra Technologies’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. And that’s just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, Zebra Technologies seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start.