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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.' 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. We note that Oil-Dri Corporation of America (NYSE:ODC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. 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. 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.
What Is Oil-Dri Corporation of America's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of October 2020 Oil-Dri Corporation of America had US$9.86m of debt, an increase on US$3.06m, over one year. However, it does have US$31.3m in cash offsetting this, leading to net cash of US$21.4m.
How Strong Is Oil-Dri Corporation of America's Balance Sheet?
The latest balance sheet data shows that Oil-Dri Corporation of America had liabilities of US$34.5m due within a year, and liabilities of US$42.6m falling due after that. On the other hand, it had cash of US$31.3m and US$39.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.55m.
Of course, Oil-Dri Corporation of America has a market capitalization of US$273.8m, 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. Despite its noteworthy liabilities, Oil-Dri Corporation of America boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Oil-Dri Corporation of America has seen its EBIT plunge 20% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Oil-Dri Corporation of America's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Oil-Dri Corporation of America 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. Over the last three years, Oil-Dri Corporation of America recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
We could understand if investors are concerned about Oil-Dri Corporation of America's liabilities, but we can be reassured by the fact it has has net cash of US$21.4m. And it impressed us with free cash flow of US$18m, being 83% of its EBIT. So we are not troubled with Oil-Dri Corporation of America's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Oil-Dri Corporation of America is showing 1 warning sign in our investment analysis , you should know about...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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