Here’s Why Novozymes (CPH: NZYM B) Can Responsibly Manage Debt
Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We note that Novozymes A / S (CPH: NZYM B) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.
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How much debt does Novozymes carry?
The image below, which you can click for more details, shows that in June 2021, Novozymes was in debt of NKr 5.69 billion, compared to NKr 5.22 billion in a year. On the other hand, it has 969.0 million crowns in cash, resulting in a net debt of around 4.72 billion crowns.
How strong is Novozymes’ balance sheet?
The latest balance sheet data shows that Novozymes had debt of SEK 4.93 billion due within one year, and debt of SEK 5.77 billion due thereafter. In compensation for these obligations, he had cash of Kroner 969.0 million as well as claims valued at Kroner 3.37 billion maturing within 12 months. Its liabilities therefore total 6.37 billion crowns more than the combination of its cash and short-term receivables.
Given that the listed Novozymes shares are worth a very impressive total of SEK 137.4 billion, it seems unlikely that this level of liabilities is a major threat. Having said that, it is clear that we must continue to monitor his record lest it get worse.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Novozymes’ net debt is only 0.95 times its EBITDA. And its EBIT covers its interest costs a whopping 76.6 times. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Novozymes’ EBIT has been fairly stable over the past year, but that shouldn’t be a problem as it doesn’t have a lot of debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Novozymes can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Novozymes has generated free cash flow of 80% of its very robust EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
The good news is that Novozymes’ demonstrated ability to cover interest costs with EBIT delights us like a fluffy puppy does a toddler. And the good news does not end there, since its conversion of EBIT into free cash flow also confirms this impression! Looking at the big picture, we think Novozymes’ use of debt looks very reasonable and we don’t care. While debt comes with risk, when used wisely, it can also generate a higher return on equity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. Concrete example: we have spotted 1 warning sign for Novozymes you must be aware.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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