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These 4 Measures Indicate That Northwest Pipe (NASDAQ:NWPX) Is Using Debt Reasonably Well
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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Northwest Pipe Company (NASDAQ:NWPX) does carry 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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Northwest Pipe
How Much Debt Does Northwest Pipe Carry?
The image below, which you can click on for greater detail, shows that at March 2022 Northwest Pipe had debt of US$90.3m, up from US$8.24m in one year. However, because it has a cash reserve of US$3.30m, its net debt is less, at about US$87.0m.
How Healthy Is Northwest Pipe's Balance Sheet?
We can see from the most recent balance sheet that Northwest Pipe had liabilities of US$69.7m falling due within a year, and liabilities of US$202.8m due beyond that. Offsetting these obligations, it had cash of US$3.30m as well as receivables valued at US$170.3m due within 12 months. So its liabilities total US$98.9m more than the combination of its cash and short-term receivables.
Northwest Pipe has a market capitalization of US$295.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Northwest Pipe's net debt to EBITDA ratio of about 2.4 suggests only moderate use of debt. And its commanding EBIT of 14.3 times its interest expense, implies the debt load is as light as a peacock feather. The bad news is that Northwest Pipe saw its EBIT decline by 13% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Northwest Pipe 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Northwest Pipe produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Our View
When it comes to the balance sheet, the standout positive for Northwest Pipe was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. To be specific, it seems about as good at (not) growing its EBIT as wet socks are at keeping your feet warm. Looking at all this data makes us feel a little cautious about Northwest Pipe's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Northwest Pipe 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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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:NWPX
Northwest Pipe
Engages in the manufacture and supply of water-related infrastructure products in North America.
Excellent balance sheet and good value.