Is Toromont Industries (TSE:TIH) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Toromont Industries Ltd. (TSE:TIH) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Toromont Industries

What Is Toromont Industries's Debt?

As you can see below, Toromont Industries had CA$648.2m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CA$670.7m in cash offsetting this, leading to net cash of CA$22.5m.

A Look At Toromont Industries' Liabilities

According to the last reported balance sheet, Toromont Industries had liabilities of CA$1.13b due within 12 months, and liabilities of CA$688.6m due beyond 12 months. On the other hand, it had cash of CA$670.7m and CA$708.0m worth of receivables due within a year. So it has liabilities totalling CA$435.9m more than its cash and near-term receivables, combined.

Given Toromont Industries has a market capitalization of CA$9.45b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Toromont Industries also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Toromont Industries saw its EBIT decline by 6.6% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Toromont Industries's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Toromont Industries 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. Looking at the most recent three years, Toromont Industries recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Toromont Industries has CA$22.5m in net cash. So we are not troubled with Toromont Industries's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Toromont Industries insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.