Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Floor & Decor Holdings, Inc. (NYSE:FND) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Floor & Decor Holdings Carry?
The image below, which you can click on for greater detail, shows that Floor & Decor Holdings had debt of US$197.6m at the end of April 2021, a reduction from US$415.1m over a year. But it also has US$354.1m in cash to offset that, meaning it has US$156.4m net cash.
How Strong Is Floor & Decor Holdings' Balance Sheet?
According to the last reported balance sheet, Floor & Decor Holdings had liabilities of US$673.0m due within 12 months, and liabilities of US$1.21b due beyond 12 months. Offsetting this, it had US$354.1m in cash and US$60.0m in receivables that were due within 12 months. So its liabilities total US$1.47b more than the combination of its cash and short-term receivables.
Of course, Floor & Decor Holdings has a titanic market capitalization of US$10.3b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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.
On top of that, Floor & Decor Holdings grew its EBIT by 54% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Floor & Decor Holdings 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. Looking at the most recent three years, Floor & Decor Holdings recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While Floor & Decor Holdings does have more liabilities than liquid assets, it also has net cash of US$156.4m. And it impressed us with its EBIT growth of 54% over the last year. So we don't think Floor & Decor Holdings's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Floor & Decor Holdings you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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