Here's Why Graco (NYSE:GGG) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Graco Inc. (NYSE:GGG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Graco

What Is Graco's Debt?

As you can see below, Graco had US$30.2m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$764.5m in cash, so it actually has US$734.3m net cash.

How Healthy Is Graco's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Graco had liabilities of US$360.4m due within 12 months and liabilities of US$102.0m due beyond that. Offsetting this, it had US$764.5m in cash and US$355.0m in receivables that were due within 12 months. So it actually has US$657.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Graco could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Graco boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Graco saw its EBIT drop by 9.4% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Graco'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. While Graco 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 most recent three years, Graco recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Graco has US$734.3m in net cash and a decent-looking balance sheet. So we don't have any problem with Graco's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Graco insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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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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.