Here's Why Beacon Roofing Supply (NASDAQ:BECN) Has A Meaningful Debt Burden

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. We note that Beacon Roofing Supply, Inc. (NASDAQ:BECN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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

View our latest analysis for Beacon Roofing Supply

What Is Beacon Roofing Supply's Net Debt?

As you can see below, at the end of September 2024, Beacon Roofing Supply had US$2.93b of debt, up from US$2.42b a year ago. Click the image for more detail. However, it does have US$71.2m in cash offsetting this, leading to net debt of about US$2.86b.

How Healthy Is Beacon Roofing Supply's Balance Sheet?

According to the last reported balance sheet, Beacon Roofing Supply had liabilities of US$1.94b due within 12 months, and liabilities of US$3.59b due beyond 12 months. On the other hand, it had cash of US$71.2m and US$2.04b worth of receivables due within a year. So it has liabilities totalling US$3.41b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Beacon Roofing Supply is worth US$7.40b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Beacon Roofing Supply's debt is 3.2 times its EBITDA, and its EBIT cover its interest expense 4.1 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Beacon Roofing Supply's EBIT was pretty flat over the last year, which isn't ideal given the debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Beacon Roofing Supply 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 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, Beacon Roofing Supply's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Beacon Roofing Supply's net debt to EBITDA and its interest cover were discouraging. At least its conversion of EBIT to free cash flow gives us reason to be optimistic. We think that Beacon Roofing Supply's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Beacon Roofing Supply is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.