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.' 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. Importantly, Fox Factory Holding Corp. (NASDAQ:FOXF) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Fox Factory Holding's Net Debt?
As you can see below, at the end of October 2020, Fox Factory Holding had US$390.3m of debt, up from US$73.0m a year ago. Click the image for more detail. However, it does have US$278.2m in cash offsetting this, leading to net debt of about US$112.0m.
How Healthy Is Fox Factory Holding's Balance Sheet?
According to the last reported balance sheet, Fox Factory Holding had liabilities of US$173.9m due within 12 months, and liabilities of US$402.7m due beyond 12 months. On the other hand, it had cash of US$278.2m and US$114.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$184.3m.
Given Fox Factory Holding has a market capitalization of US$4.41b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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.
Fox Factory Holding's net debt is only 0.78 times its EBITDA. And its EBIT easily covers its interest expense, being 15.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Fox Factory Holding grew its EBIT by 3.5% in the last year, making that debt load look even more manageable. 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 Fox Factory Holding'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, 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. In the last three years, Fox Factory Holding's free cash flow amounted to 41% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Happily, Fox Factory Holding's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! All these things considered, it appears that Fox Factory Holding can comfortably handle its current debt levels. 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. 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. Consider risks, for instance. Every company has them, and we've spotted 4 warning signs for Fox Factory Holding you should know about.
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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