Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Fox Factory Holding Corp. (NASDAQ:FOXF) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Fox Factory Holding Carry?
As you can see below, at the end of June 2019, Fox Factory Holding had US$77.6m of debt, up from US$65.9m a year ago. Click the image for more detail. However, because it has a cash reserve of US$39.0m, its net debt is less, at about US$38.5m.
How Healthy Is Fox Factory Holding's Balance Sheet?
The latest balance sheet data shows that Fox Factory Holding had liabilities of US$106.0m due within a year, and liabilities of US$89.5m falling due after that. Offsetting these obligations, it had cash of US$39.0m as well as receivables valued at US$95.7m due within 12 months. So it has liabilities totalling US$60.8m more than its cash and near-term receivables, combined.
Given Fox Factory Holding has a market capitalization of US$2.59b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, Fox Factory Holding 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Fox Factory Holding's net debt is only 0.32 times its EBITDA. And its EBIT easily covers its interest expense, being 32.4 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Fox Factory Holding has boosted its EBIT by 36%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Fox Factory Holding'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Fox Factory Holding recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Fox Factory Holding'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 the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, Fox Factory Holding seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Fox Factory Holding insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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.
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