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 note that Comfort Systems USA, Inc. (NYSE:FIX) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Comfort Systems USA Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Comfort Systems USA had US$235.7m of debt, an increase on US$226.1m, over one year. However, because it has a cash reserve of US$54.9m, its net debt is less, at about US$180.8m.
A Look At Comfort Systems USA's Liabilities
Zooming in on the latest balance sheet data, we can see that Comfort Systems USA had liabilities of US$692.9m due within 12 months and liabilities of US$368.0m due beyond that. Offsetting these obligations, it had cash of US$54.9m as well as receivables valued at US$728.0m due within 12 months. So it has liabilities totalling US$278.1m more than its cash and near-term receivables, combined.
Since publicly traded Comfort Systems USA shares are worth a total of US$2.96b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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.
Comfort Systems USA has a low net debt to EBITDA ratio of only 0.72. And its EBIT covers its interest expense a whopping 22.8 times over. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that Comfort Systems USA has been able to increase its EBIT by 20% in twelve months, making it easier to pay down debt. 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 Comfort Systems USA 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.
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. Over the last three years, Comfort Systems USA recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Comfort Systems USA's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Considering this range of factors, it seems to us that Comfort Systems USA is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. 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. For example, we've discovered 3 warning signs for Comfort Systems USA (1 can't be ignored!) that you should be aware of before investing here.
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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