Howard Marks put 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 every investor practice that I know is worried. ” When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that Avery Dennison Company (NYSE: AVY) uses debt in its business. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
How much debt does Avery Dennison have?
The image below, which you can click for more details, shows Avery Dennison owed $ 2.08 billion in debt at the end of July 2021, a reduction from $ 2.27 billion. US dollars over one year. On the other hand, it has $ 377.9 million in cash, resulting in net debt of around $ 1.70 billion.
NYSE: AVY Debt to Equity History October 20, 2021
How healthy is Avery Dennison’s track record?
We can see from the most recent balance sheet that Avery Dennison had liabilities of US $ 2.08 billion maturing within one year and liabilities of US $ 2.64 billion maturing within one year. of the. In compensation for these obligations, he had cash of US $ 377.9 million as well as receivables valued at US $ 1.34 billion within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 3.00 billion.
Given that Avery Dennison has a whopping market cap of US $ 17.5 billion, it’s hard to believe that these liabilities pose a significant 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). Thus, we look at debt over earnings with and without amortization charges.
Avery Dennison’s net debt is only 1.4 times its EBITDA. And its EBIT covers its interest costs 16.7 times more. So we’re pretty relaxed about its ultra-conservative use of debt. On top of that, we are happy to report that Avery Dennison has increased its EBIT by 36%, reducing the specter of future debt repayments. When analyzing debt levels, the balance sheet is the obvious starting point. But it’s future profits, more than anything, that will determine Avery Dennison’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts‘ earnings forecasts.
Finally, a business can only pay off its debts with hard cash, not with book profits. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Avery Dennison has recorded free cash flow of 57% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
The good news is that Avery Dennison’s demonstrated ability to cover interest costs with his EBIT delights us like a fluffy puppy does a toddler. And the good news doesn’t end there, because its EBIT growth rate also supports this impression! Zooming out, Avery Dennison appears to be using the debt quite sensibly; and that gets the nod from us. After all, reasonable leverage can increase returns on equity. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 1 warning sign for Avery Dennison that you need to be aware of.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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