Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that CSW Industrials, Inc. (NASDAQ:CSWI) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is CSW Industrials's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 CSW Industrials had US$22.7m of debt, an increase on US$20.0m, over one year. However, because it has a cash reserve of US$10.2m, its net debt is less, at about US$12.5m.
How Strong Is CSW Industrials's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that CSW Industrials had liabilities of US$44.8m due within 12 months and liabilities of US$45.4m due beyond that. Offsetting this, it had US$10.2m in cash and US$72.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$7.14m.
Having regard to CSW Industrials's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$1.06b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, CSW Industrials has virtually no net debt, so it's fair to say it does not have a heavy debt load!
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
CSW Industrials has a low net debt to EBITDA ratio of only 0.16. And its EBIT covers its interest expense a whopping 41.2 times over. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that CSW Industrials has been able to increase its EBIT by 21% in twelve months, making it easier to pay down 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 CSW Industrials 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. 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, CSW Industrials produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
CSW Industrials'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. Overall, we don't think CSW Industrials is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. 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 CSW Industrials's earnings per share history for free.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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