Is Avanos Medical (NYSE:AVNS) using too much debt?

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Avanos Medical, Inc. (NYSE: AVNS) has debt on its balance sheet. But the real question is whether this debt makes the business risky.

When is debt a problem?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for Avanos Medical

What is Avanos Medical’s net debt?

You can click on the chart below for historical numbers, but it shows Avanos Medical had $130.0 million in debt in December 2021, up from $180.0 million a year prior. However, he has $118.5 million in cash to offset this, resulting in a net debt of around $11.5 million.

NYSE: AVNS Debt to Equity History May 3, 2022

How healthy is Avanos Medical’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Avanos Medical had liabilities of US$139.2 million due within 12 months and liabilities of US$191.5 million due beyond. In return, it had $118.5 million in cash and $131.2 million in receivables due within 12 months. Thus, its liabilities total $81.0 million more than the combination of its cash and short-term receivables.

Given that Avanos Medical has a market cap of US$1.38 billion, it’s hard to believe that these liabilities pose much of a threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate. But either way, Avanos Medical has virtually no net debt, so it’s fair to say that it doesn’t have a lot of debt!

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

With a net debt of just 0.18 times EBITDA, Avanos Medical is arguably quite conservative. And this view is supported by strong interest coverage, with EBIT amounting to 8.5 times interest expense over the past year. Even better, Avanos Medical increased its EBIT by 125% last year, which is an impressive improvement. This boost will make it even easier to pay off debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But future revenues, more than anything, will determine Avanos Medical’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Fortunately for all shareholders, Avanos Medical has actually produced more free cash flow than EBIT over the past two years. There’s nothing better than incoming money to stay in the good books of your lenders.

Our point of view

The conversion of EBIT to free cash flow by Avanos Medical suggests it can manage its debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And this is only the beginning of good news since its EBIT growth rate is also very encouraging. It should also be noted that Avanos Medical is in the medical equipment industry, which is often seen as quite defensive. We believe that Avanos Medical is no more indebted to its lenders than birds are to bird watchers. For investment nerds like us, his track record is almost charming. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 1 warning sign for Avanos Medical you should be aware.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.