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.' 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. Importantly, Martin Marietta Materials, Inc. (NYSE:MLM) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Martin Marietta Materials Carry?
As you can see below, Martin Marietta Materials had US$3.12b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. And it doesn't have much cash, so its net debt is about the same.
A Look At Martin Marietta Materials's Liabilities
Zooming in on the latest balance sheet data, we can see that Martin Marietta Materials had liabilities of US$822.2m due within 12 months and liabilities of US$4.24b due beyond that. Offsetting this, it had US$53.6m in cash and US$710.6m in receivables that were due within 12 months. So it has liabilities totalling US$4.30b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Martin Marietta Materials is worth a massive US$15.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Martin Marietta Materials's debt is 2.7 times its EBITDA, and its EBIT cover its interest expense 5.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. We saw Martin Marietta Materials grow its EBIT by 4.6% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to 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 Martin Marietta Materials 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Martin Marietta Materials's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
We weren't impressed with Martin Marietta Materials's conversion of EBIT to free cash flow, and its net debt to EBITDA made us cautious. Balancing that a bit, it has a demonstrated ability EBIT growth rate. Looking at all this data makes us feel a little cautious about Martin Marietta Materials's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Martin Marietta Materials insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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