Is Dorman Products (NASDAQ:DORM) Using Too Much Debt?

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 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 Dorman Products, Inc. (NASDAQ:DORM) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Dorman Products

What Is Dorman Products's Debt?

The image below, which you can click on for greater detail, shows that Dorman Products had debt of US$561.0m at the end of March 2024, a reduction from US$707.4m over a year. On the flip side, it has US$34.4m in cash leading to net debt of about US$526.6m.

A Look At Dorman Products' Liabilities

Zooming in on the latest balance sheet data, we can see that Dorman Products had liabilities of US$465.6m due within 12 months and liabilities of US$580.0m due beyond that. Offsetting these obligations, it had cash of US$34.4m as well as receivables valued at US$486.4m due within 12 months. So it has liabilities totalling US$524.9m more than its cash and near-term receivables, combined.

Given Dorman Products has a market capitalization of US$2.69b, 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.

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 Dorman Products's low debt to EBITDA ratio of 1.5 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.3 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. In addition to that, we're happy to report that Dorman Products has boosted its EBIT by 40%, 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 Dorman Products'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, Dorman Products recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Dorman Products's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And its net debt to EBITDA is good too. Looking at all the aforementioned factors together, it strikes us that Dorman Products can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Dorman Products that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

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