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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Cavco Industries, Inc. (NASDAQ:CVCO) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Cavco Industries Carry?
You can click the graphic below for the historical numbers, but it shows that Cavco Industries had US$15.2m of debt in September 2019, down from US$57.2m, one year before. However, it does have US$203.9m in cash offsetting this, leading to net cash of US$188.7m.
A Look At Cavco Industries's Liabilities
According to the last reported balance sheet, Cavco Industries had liabilities of US$169.7m due within 12 months, and liabilities of US$31.1m due beyond 12 months. On the other hand, it had cash of US$203.9m and US$44.9m worth of receivables due within a year. So it can boast US$47.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Cavco Industries could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Cavco Industries has more cash than debt is arguably a good indication that it can manage its debt safely.
Cavco Industries's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Cavco Industries 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 company can only pay off debt with cold hard cash, not accounting profits. Cavco Industries may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Cavco Industries recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While we empathize with investors who find debt concerning, you should keep in mind that Cavco Industries has net cash of US$188.7m, as well as more liquid assets than liabilities. So we don't think Cavco Industries's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Cavco Industries's earnings per share history for free.
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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