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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ 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. Powell Industries, Inc. (NASDAQ:POWL) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Powell Industries’s Net Debt?
As you can see below, Powell Industries had US$1.20m of debt at March 2019, down from US$1.60m a year prior. But on the other hand it also has US$72.4m in cash, leading to a US$71.2m net cash position.
How Healthy Is Powell Industries’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Powell Industries had liabilities of US$110.3m due within 12 months and liabilities of US$11.0m due beyond that. Offsetting this, it had US$72.4m in cash and US$152.1m in receivables that were due within 12 months. So it actually has US$103.1m more liquid assets than total liabilities.
This excess liquidity suggests that Powell Industries is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Powell Industries boasts net cash, so it’s fair to say it does not have a heavy debt load!
Although Powell Industries made a loss at the EBIT level, last year, it was also good to see that it generated US$2.5m in EBIT over the last twelve months. 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 Powell Industries’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Powell Industries has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Powell Industries actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us excited like the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company’s debt, in this case Powell Industries has US$71m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$4.4m, being 174% of its EBIT. So is Powell Industries’s debt a risk? It doesn’t seem so to us. Over time, share prices tend to follow earnings per share, so if you’re interested in Powell Industries, you may well want to click here to check an interactive graph of its earnings per share history.
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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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.