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. 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, CSW Industrials, Inc. (NASDAQ:CSWI) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is CSW Industrials's Net Debt?
As you can see below, CSW Industrials had US$12.3m of debt at September 2019, down from US$21.8m a year prior. However, its balance sheet shows it holds US$23.7m in cash, so it actually has US$11.3m net cash.
How Strong Is CSW Industrials's Balance Sheet?
According to the last reported balance sheet, CSW Industrials had liabilities of US$50.7m due within 12 months, and liabilities of US$34.2m due beyond 12 months. Offsetting these obligations, it had cash of US$23.7m as well as receivables valued at US$68.7m due within 12 months. So it can boast US$7.45m more liquid assets than total liabilities.
Having regard to CSW Industrials's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$1.14b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that CSW Industrials has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that CSW Industrials grew its EBIT at 12% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if CSW Industrials can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While CSW Industrials has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, CSW Industrials generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that CSW Industrials has net cash of US$11.3m, as well as more liquid assets than liabilities. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in US$63m. So is CSW Industrials's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in CSW Industrials, you may well want to click here to check an interactive graph of its earnings per share history.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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