Here's Why Modine Manufacturing (NYSE:MOD) Can Manage Its Debt Responsibly

Warren Buffett famously said, '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. We note that Modine Manufacturing Company (NYSE:MOD) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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

Check out our latest analysis for Modine Manufacturing

How Much Debt Does Modine Manufacturing Carry?

You can click the graphic below for the historical numbers, but it shows that Modine Manufacturing had US$350.0m of debt in March 2023, down from US$374.6m, one year before. However, it does have US$70.6m in cash offsetting this, leading to net debt of about US$279.4m.

How Strong Is Modine Manufacturing's Balance Sheet?

The latest balance sheet data shows that Modine Manufacturing had liabilities of US$507.1m due within a year, and liabilities of US$459.2m falling due after that. Offsetting this, it had US$70.6m in cash and US$428.2m in receivables that were due within 12 months. So it has liabilities totalling US$467.5m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Modine Manufacturing has a market capitalization of US$1.99b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt sitting at just 1.3 times EBITDA, Modine Manufacturing is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.9 times the interest expense over the last year. On top of that, Modine Manufacturing grew its EBIT by 65% 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 it is future earnings, more than anything, that will determine Modine Manufacturing'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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Modine Manufacturing'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.

Our View

The good news is that Modine Manufacturing's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. And its interest cover is good too. All these things considered, it appears that Modine Manufacturing 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. 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 3 warning signs for Modine Manufacturing (1 is a bit unpleasant) you should be aware of.

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.