Stock Analysis

These 4 Measures Indicate That Dorman Products (NASDAQ:DORM) Is Using Debt Safely

NasdaqGS:DORM
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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. As with many other companies Dorman Products, Inc. (NASDAQ:DORM) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Dorman Products

What Is Dorman Products's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Dorman Products had US$229.4m of debt, an increase on none, over one year. However, it does have US$53.4m in cash offsetting this, leading to net debt of about US$175.9m.

debt-equity-history-analysis
NasdaqGS:DORM Debt to Equity History May 17th 2022

A Look At Dorman Products' Liabilities

We can see from the most recent balance sheet that Dorman Products had liabilities of US$652.6m falling due within a year, and liabilities of US$112.3m due beyond that. Offsetting this, it had US$53.4m in cash and US$456.1m in receivables that were due within 12 months. So its liabilities total US$255.4m more than the combination of its cash and short-term receivables.

Of course, Dorman Products has a market capitalization of US$3.17b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Dorman Products's net debt is only 0.82 times its EBITDA. And its EBIT covers its interest expense a whopping 54.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Dorman Products has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Dorman Products 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Dorman Products produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Dorman Products's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think Dorman Products's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Dorman Products, 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.

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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.

About NasdaqGS:DORM

Dorman Products

Supplies replacement and upgrade parts for passenger cars, light trucks, medium- and heavy-duty trucks, utility terrain vehicles, and all-terrain vehicles in the motor vehicle aftermarket industry in the United States and internationally.

Solid track record with excellent balance sheet.