Embla Medical hf (CPH:EMBLA) appears to be using its debt quite wisely

Legendary fund manager Li Lu (whom 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.” When we think about how risky a company is, we look We always recommend the use of debt, because over-indebtedness can lead to ruin. What is important is Embla Medical hf. (CPH:EMBLA) carries debt. But the real question is whether this debt makes the company risky.

What risk does debt bring with it?

Debt helps a business until the business has difficulty paying it off, whether with new capital or free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company must dilute shareholders at a cheap share price just to get debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high returns. When we examine debt levels, we first consider both cash and debt levels together.

Check out our latest analysis for Embla Medical hf

How much debt does Embla Medical hf have?

As you can see below, Embla Medical hf had debt of US$399.1m at the end of September 2024, an increase from US$332.5m a year ago. Click on the image for more details. On the other hand, the company has cash of $81.2 million, leading to net debt of about $317.9 million.

How healthy is Embla Medical hf’s balance sheet?

The most recent balance sheet shows that Embla Medical hf had liabilities of US$201.6m due within a year, and liabilities of US$594.1m due beyond that became. Offsetting these obligations, it had cash of US$81.2m as well as receivables valued at US$129.6m due within 12 months. So its liabilities total US$584.8m more than the combination of its cash and short-term receivables.

Embla Medical hf has a market capitalization of US$2.11 billion, so it could very likely raise cash to improve its balance sheet if needed. But we definitely want to keep our eyes open for signs that debt brings too much risk.

We use two main ratios to inform us about the level of debt relative to profits. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times earnings before interest and tax (EBIT) cover interest expense (or interest cover, for short). . The advantage of this approach is that we take into account 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).

Embla Medical hf’s debt is 2.6 times its EBITDA and its EBIT covers interest expenses by 5.6 times. This suggests that while the debt is significant, we wouldn’t call it problematic. We note that Embla Medical hf grew its EBIT by 28% over the last year, which should make it easier to pay down debt in the future. When analyzing debt levels, the balance sheet is the obvious place to start. But it is future earnings that will determine whether Embla Medical hf can maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

After all, a company needs free cash flow to pay off debt; Book profits are simply not enough. So it’s worth checking how much of that EBIT is covered by free cash flow. Over the last three years, Embla Medical hf generated stable free cash flow accounting for 62% of its EBIT, which is about what we would expect. That ready cash means it can pay down its debt whenever it wants.

Our view

The good news is that Embla Medical hf’s proven ability to grow its EBIT delights us like a fluffy puppy delights a toddler. On a more bleak note, net debt to EBITDA is something we’re a bit concerned about. It’s also worth noting that Embla Medical hf operates in the medical device industry, which is often viewed as quite defensive. If we consider the above factors, it looks like Embla Medical hf is quite sensible about its use of debt. While this involves some risk, it can also increase returns for shareholders. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – quite the opposite. For example, we discovered it 1 warning sign for Embla Medical hf what you should be aware of before investing here.

Ultimately, it’s often better to focus on companies that are free of net debt. You can access our special list of such companies (all with a track record of growing profits). It’s free.

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