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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.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Dycom Industries, Inc. (NYSE:DY) 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 and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
What Is Dycom Industries’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of April 2019 Dycom Industries had US$878.6m of debt, an increase on US$760.6m, over one year. However, it does have US$47.7m in cash offsetting this, leading to net debt of about US$830.9m.
How Strong Is Dycom Industries’s Balance Sheet?
We can see from the most recent balance sheet that Dycom Industries had liabilities of US$341.7m falling due within a year, and liabilities of US$1.05b due beyond that. On the other hand, it had cash of US$47.7m and US$1.00b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$338.3m.
Given Dycom Industries has a market capitalization of US$1.76b, it’s hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Since Dycom Industries does have net debt, we think it is worthwhile for shareholders to keep an eye on the balance sheet, over time.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While Dycom Industries’s debt to EBITDA ratio (2.79) suggests that it uses debt fairly modestly, its interest cover is very weak, at 2.47. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Dycom Industries’s EBIT was down 28% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Dycom Industries can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Dycom Industries’s free cash flow amounted to 21% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
Mulling over Dycom Industries’s attempt at (not) growing its EBIT, we’re certainly not enthusiastic. But at least its level of total liabilities is not so bad. Overall, we think it’s fair to say that Dycom Industries has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. Over time, share prices tend to follow earnings per share, so if you’re interested in Dycom Industries, you may well want to click here to check an interactive graph of its earnings per share history.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.