David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Construction Partners, Inc. (NASDAQ:ROAD) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Construction Partners's Debt?
As you can see below, at the end of March 2021, Construction Partners had US$86.8m of debt, up from US$67.3m a year ago. Click the image for more detail. However, it does have US$33.7m in cash offsetting this, leading to net debt of about US$53.0m.
A Look At Construction Partners' Liabilities
Zooming in on the latest balance sheet data, we can see that Construction Partners had liabilities of US$126.3m due within 12 months and liabilities of US$100.4m due beyond that. Offsetting these obligations, it had cash of US$33.7m as well as receivables valued at US$143.0m due within 12 months. So its liabilities total US$50.0m more than the combination of its cash and short-term receivables.
Since publicly traded Construction Partners shares are worth a total of US$1.62b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Construction Partners's net debt is only 0.54 times its EBITDA. And its EBIT easily covers its interest expense, being 30.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Construction Partners's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of 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 Construction Partners 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Construction Partners's free cash flow amounted to 30% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Construction Partners's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Construction Partners can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. We'd be motivated to research the stock further if we found out that Construction Partners insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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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