Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Nordson Carry?

As you can see below, at the end of April 2024, Nordson had US$1.53b of debt, up from US$949.2m a year ago. Click the image for more detail. However, it also had US$125.4m in cash, and so its net debt is US$1.41b.

How Healthy Is Nordson's Balance Sheet?

We can see from the most recent balance sheet that Nordson had liabilities of US$536.0m falling due within a year, and liabilities of US$1.85b due beyond that. Offsetting these obligations, it had cash of US$125.4m as well as receivables valued at US$530.3m due within 12 months. So its liabilities total US$1.73b more than the combination of its cash and short-term receivables.

Of course, Nordson has a titanic market capitalization of US$12.9b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Nordson's net debt of 1.7 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 9.1 times its interest expenses harmonizes with that theme. We saw Nordson grow its EBIT by 7.2% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Nordson can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Nordson generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Nordson's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its interest cover is also very heartening. When we consider the range of factors above, it looks like Nordson is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Nordson is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com