These 4 Measures Indicate That Construction Partners (NASDAQ:ROAD) Is Using Debt Reasonably Well

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.' 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 can see that Construction Partners, Inc. (NASDAQ:ROAD) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Construction Partners

How Much Debt Does Construction Partners Carry?

As you can see below, at the end of June 2024, Construction Partners had US$477.8m of debt, up from US$419.4m a year ago. Click the image for more detail. However, it does have US$56.3m in cash offsetting this, leading to net debt of about US$421.5m.

How Strong Is Construction Partners' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Construction Partners had liabilities of US$346.0m due within 12 months and liabilities of US$533.1m due beyond that. On the other hand, it had cash of US$56.3m and US$373.4m worth of receivables due within a year. So its liabilities total US$449.4m more than the combination of its cash and short-term receivables.

Of course, Construction Partners has a market capitalization of US$4.82b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Construction Partners has net debt worth 2.1 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.3 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Notably, Construction Partners's EBIT launched higher than Elon Musk, gaining a whopping 145% on last year. 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 Construction Partners'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Construction Partners's free cash flow amounted to 38% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Construction Partners's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its interest cover does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Construction Partners can handle its debt fairly comfortably. 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Construction Partners you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.