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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Floor & Decor Holdings, Inc. (NYSE:FND) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Floor & Decor Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2020 Floor & Decor Holdings had debt of US$209.5m, up from US$143.3m in one year. But on the other hand it also has US$271.1m in cash, leading to a US$61.6m net cash position.
How Healthy Is Floor & Decor Holdings's Balance Sheet?
The latest balance sheet data shows that Floor & Decor Holdings had liabilities of US$618.9m due within a year, and liabilities of US$1.16b falling due after that. On the other hand, it had cash of US$271.1m and US$81.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.43b.
Of course, Floor & Decor Holdings has a market capitalization of US$9.81b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Floor & Decor Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that Floor & Decor Holdings has boosted its EBIT by 32%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Floor & Decor Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Floor & Decor Holdings 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. In the last three years, Floor & Decor Holdings's free cash flow amounted to 41% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While Floor & Decor Holdings does have more liabilities than liquid assets, it also has net cash of US$61.6m. And it impressed us with its EBIT growth of 32% over the last year. So is Floor & Decor Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Floor & Decor Holdings that you should be aware of before investing here.
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.
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. 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.
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