Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Nordson Corporation (NASDAQ:NDSN) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Nordson
What Is Nordson’s Net Debt?
As you can see below, Nordson had US$737.9m of debt at October 2022, down from US$815.9m a year prior. On the flip side, it has US$163.5m in cash leading to net debt of about US$574.4m.
How Strong Is Nordson’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Nordson had liabilities of US$834.2m due within 12 months and liabilities of US$691.8m due beyond that. Offsetting these obligations, it had cash of US$163.5m as well as receivables valued at US$532.3m due within 12 months. So its liabilities total US$830.3m more than the combination of its cash and short-term receivables.
Since publicly traded Nordson shares are worth a very impressive total of US$13.7b, 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Nordson’s net debt is only 0.75 times its EBITDA. And its EBIT easily covers its interest expense, being 32.7 times the size. So we’re pretty relaxed about its super-conservative use of debt. Fortunately, Nordson grew its EBIT by 9.5% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Nordson’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, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Nordson recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
Our View
Nordson’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. Looking at the bigger picture, we think Nordson’s use of debt seems quite reasonable and we’re not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. We’ve identified 1 warning sign with Nordson , and understanding them should be part of your investment process.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
What are the risks and opportunities for Nordson?
Nordson Corporation engineers, manufactures, and markets products and systems to dispense, apply, and control adhesives, coatings, polymers, sealants, biomaterials, and other fluids worldwide.
Rewards
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Trading at 1.5% below our estimate of its fair value
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Earnings are forecast to grow 9.14% per year
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Earnings grew by 12.9% over the past year
Risks
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Significant insider selling over the past 3 months
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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.
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