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. As with many other companies Fastenal Company (NASDAQ:FAST) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. 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 Fastenal Carry?
You can click the graphic below for the historical numbers, but it shows that Fastenal had US$345.0m of debt in December 2019, down from US$500.0m, one year before. However, it also had US$174.9m in cash, and so its net debt is US$170.1m.
How Healthy Is Fastenal’s Balance Sheet?
According to the last reported balance sheet, Fastenal had liabilities of US$544.7m due within 12 months, and liabilities of US$589.6m due beyond 12 months. Offsetting these obligations, it had cash of US$174.9m as well as receivables valued at US$741.8m due within 12 months. So it has liabilities totalling US$217.6m more than its cash and near-term receivables, combined.
This state of affairs indicates that Fastenal’s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it’s very unlikely that the US$20.4b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Fastenal has a very light debt load indeed.
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.
Fastenal has a low net debt to EBITDA ratio of only 0.14. And its EBIT easily covers its interest expense, being 78.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Fastenal grew its EBIT by 5.7% in the last year, making that debt load look even more manageable. 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 Fastenal’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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Fastenal recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
The good news is that Fastenal’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, Fastenal seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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 instance, we’ve identified 1 warning sign for Fastenal that you should be aware of.
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.
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