Generac Holdings (NYSE:GNRC) Has A Somewhat Strained Balance Sheet

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. Importantly, Generac Holdings Inc. (NYSE:GNRC) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Generac Holdings

What Is Generac Holdings's Net Debt?

As you can see below, at the end of June 2023, Generac Holdings had US$1.59b of debt, up from US$1.34b a year ago. Click the image for more detail. However, because it has a cash reserve of US$192.8m, its net debt is less, at about US$1.40b.

A Look At Generac Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Generac Holdings had liabilities of US$936.8m due within 12 months and liabilities of US$1.96b due beyond that. Offsetting these obligations, it had cash of US$192.8m as well as receivables valued at US$540.3m due within 12 months. So it has liabilities totalling US$2.16b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Generac Holdings has a market capitalization of US$5.12b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Generac Holdings's debt is 2.9 times its EBITDA, and its EBIT cover its interest expense 4.1 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Even worse, Generac Holdings saw its EBIT tank 56% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Generac Holdings'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Generac Holdings recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Generac Holdings's EBIT growth rate was disappointing. But at least its level of total liabilities is not so bad. Overall, we think it's fair to say that Generac Holdings has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Generac Holdings (1 is significant) you should be aware of.

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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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.