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.' 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. We note that Masonite International Corporation (NYSE:DOOR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Masonite International's Debt?
As you can see below, Masonite International had US$792.0m of debt, at July 2021, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$328.6m, its net debt is less, at about US$463.4m.
How Healthy Is Masonite International's Balance Sheet?
We can see from the most recent balance sheet that Masonite International had liabilities of US$344.0m falling due within a year, and liabilities of US$1.06b due beyond that. Offsetting this, it had US$328.6m in cash and US$365.2m in receivables that were due within 12 months. So it has liabilities totalling US$713.4m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Masonite International has a market capitalization of US$2.81b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Looking at its net debt to EBITDA of 1.2 and interest cover of 6.1 times, it seems to us that Masonite International is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. In addition to that, we're happy to report that Masonite International has boosted its EBIT by 47%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Masonite International's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
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. During the last three years, Masonite International produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Masonite International's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, Masonite International seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Masonite International you should be aware of.
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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What are the risks and opportunities for Masonite International?
Trading at 48.8% below our estimate of its fair value
Earnings are forecast to grow 4.54% per year
Debt is not well covered by operating cash flow
Significant insider selling over the past 3 months
Large one-off items impacting financial results
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.
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Masonite International Corporation designs, manufactures, markets, and distributes interior and exterior doors for the new construction and repair, renovation, and remodeling sectors of the residential and non-residential building construction markets worldwide.
Undervalued with mediocre balance sheet.