These 4 Measures Indicate That XPEL (NASDAQ:XPEL) Is Using Debt Reasonably Well

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.' 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 XPEL, Inc. (NASDAQ:XPEL) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for XPEL

What Is XPEL's Net Debt?

As you can see below, at the end of September 2022, XPEL had US$26.1m of debt, up from US$579.4k a year ago. Click the image for more detail. On the flip side, it has US$10.2m in cash leading to net debt of about US$15.9m.

How Strong Is XPEL's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that XPEL had liabilities of US$31.8m due within 12 months and liabilities of US$41.5m due beyond that. Offsetting this, it had US$10.2m in cash and US$17.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$45.1m.

Of course, XPEL has a market capitalization of US$2.21b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, XPEL has a very light debt load indeed.

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.

XPEL's net debt is only 0.27 times its EBITDA. And its EBIT covers its interest expense a whopping 47.2 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, XPEL grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its 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 XPEL can strengthen its balance sheet over time. 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. Looking at the most recent three years, XPEL recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, XPEL's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Looking at the bigger picture, we think XPEL's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 instance, we've identified 2 warning signs for XPEL (1 makes us a bit uncomfortable) you should be aware of.

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.