Legendary fund manager Li Lu (who 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.' 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. As with many other companies ICU Medical, Inc. (NASDAQ:ICUI) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for ICU Medical

What Is ICU Medical's Debt?

As you can see below, at the end of June 2022, ICU Medical had US$1.66b of debt, up from none a year ago. Click the image for more detail. However, it does have US$285.6m in cash offsetting this, leading to net debt of about US$1.37b.

How Strong Is ICU Medical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ICU Medical had liabilities of US$486.0m due within 12 months and liabilities of US$2.02b due beyond that. Offsetting this, it had US$285.6m in cash and US$219.6m in receivables that were due within 12 months. So its liabilities total US$2.00b more than the combination of its cash and short-term receivables.

ICU Medical has a market capitalization of US$3.87b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.9 times and a disturbingly high net debt to EBITDA ratio of 6.3 hit our confidence in ICU Medical like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, ICU Medical's EBIT was down 62% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that 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 ICU Medical 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, ICU Medical produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, ICU Medical's net debt to EBITDA left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We should also note that Medical Equipment industry companies like ICU Medical commonly do use debt without problems. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making ICU Medical stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example ICU Medical has 4 warning signs (and 1 which is concerning) we think 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.