ICON (NASDAQ:ICLR) seems to be using debt quite wisely

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Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies ICON Limited Company (NASDAQ:ICLR) uses debt. But does this debt worry shareholders?

When is debt dangerous?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

See our latest analysis for ICON

What is ICON’s debt?

As you can see below, at the end of June 2022, ICON had $5.05 billion in debt, up from $350.0 million a year ago. Click on the image for more details. However, since he has a cash reserve of $616.6 million, his net debt is less, at around $4.43 billion.

NasdaqGS: ICLR Debt to Equity History August 26, 2022

How healthy is ICON’s balance sheet?

According to the last published balance sheet, ICON had liabilities of US$2.48 billion due within 12 months and liabilities of US$6.41 billion due beyond 12 months. On the other hand, it had liquid assets of 616.6 million dollars and 2.18 billion dollars of receivables at less than one year. Thus, its liabilities total $6.09 billion more than the combination of its cash and short-term receivables.

ICON has a very large market capitalization of US$18.7 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider 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 ).

ICON has a debt to EBITDA ratio of 3.6 and its EBIT covered its interest expense 2.7 times. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. The good news is that ICON has grown its EBIT smoothly by 37% over the past twelve months. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of managing debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine ICON’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, ICON has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our point of view

Fortunately, ICON’s impressive conversion of EBIT to free cash flow means it has the upper hand on its debt. But the harsh truth is that we are concerned about his coverage of interests. Looking at all of the aforementioned factors together, it seems to us that ICON can manage its debt quite comfortably. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 4 warning signs for ICON (of which 1 is significant!) that you should know.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.

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

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