David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Merit Medical Systems, Inc. (NASDAQ:MMSI) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Merit Medical Systems's Debt?

As you can see below, at the end of June 2024, Merit Medical Systems had US$801.3m of debt, up from US$339.0m a year ago. Click the image for more detail. However, it does have US$636.9m in cash offsetting this, leading to net debt of about US$164.4m.

How Strong Is Merit Medical Systems' Balance Sheet?

We can see from the most recent balance sheet that Merit Medical Systems had liabilities of US$186.2m falling due within a year, and liabilities of US$903.2m due beyond that. On the other hand, it had cash of US$636.9m and US$197.4m worth of receivables due within a year. So its liabilities total US$255.1m more than the combination of its cash and short-term receivables.

Given Merit Medical Systems has a market capitalization of US$5.27b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Merit Medical Systems's net debt is only 0.67 times its EBITDA. And its EBIT easily covers its interest expense, being 17.5 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Merit Medical Systems grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its 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 Merit Medical Systems 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Merit Medical Systems 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

Merit Medical Systems's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. It's also worth noting that Merit Medical Systems is in the Medical Equipment industry, which is often considered to be quite defensive. It looks Merit Medical Systems has no trouble standing on its own two feet, and it has no reason to fear its lenders. For investing nerds like us its balance sheet is almost charming. Another factor that would give us confidence in Merit Medical Systems would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.