David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Patrick Industries, Inc. (NASDAQ:PATK) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Patrick Industries
What Is Patrick Industries's Debt?
The chart below, which you can click on for greater detail, shows that Patrick Industries had US$1.28b in debt in December 2022; about the same as the year before. Net debt is about the same, since the it doesn't have much cash.
How Strong Is Patrick Industries' Balance Sheet?
According to the last reported balance sheet, Patrick Industries had liabilities of US$367.2m due within 12 months, and liabilities of US$1.46b due beyond 12 months. Offsetting this, it had US$22.8m in cash and US$172.9m in receivables that were due within 12 months. So it has liabilities totalling US$1.63b more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of US$1.62b, we think shareholders really should watch Patrick Industries's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
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.
With a debt to EBITDA ratio of 2.0, Patrick Industries uses debt artfully but responsibly. And the alluring interest cover (EBIT of 8.2 times interest expense) certainly does not do anything to dispel this impression. It is well worth noting that Patrick Industries's EBIT shot up like bamboo after rain, gaining 41% in the last twelve months. That'll make it easier to manage its debt. 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 Patrick Industries'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Patrick Industries recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Our View
On our analysis Patrick Industries's EBIT growth rate should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. Considering this range of data points, we think Patrick Industries is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Patrick Industries is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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:PATK
Patrick Industries
Manufactures and distributes component products and materials for the recreational vehicle, marine, manufactured housing, and industrial markets in the United States, Mexico, China, and Canada.
Good value with adequate balance sheet.
