Is W.W. Grainger (NYSE:GWW) Using Too Much Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, W.W. Grainger, Inc. (NYSE:GWW) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for W.W. Grainger

How Much Debt Does W.W. Grainger Carry?

The chart below, which you can click on for greater detail, shows that W.W. Grainger had US$2.32b in debt in September 2023; about the same as the year before. On the flip side, it has US$601.0m in cash leading to net debt of about US$1.72b.

How Strong Is W.W. Grainger's Balance Sheet?

The latest balance sheet data shows that W.W. Grainger had liabilities of US$1.90b due within a year, and liabilities of US$2.86b falling due after that. Offsetting these obligations, it had cash of US$601.0m as well as receivables valued at US$2.44b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.71b.

Since publicly traded W.W. Grainger shares are worth a very impressive total of US$40.3b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

W.W. Grainger has a low net debt to EBITDA ratio of only 0.62. And its EBIT easily covers its interest expense, being 27.5 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that W.W. Grainger grew its EBIT at 13% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if W.W. Grainger can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, W.W. Grainger produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, W.W. Grainger's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Zooming out, W.W. Grainger seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - W.W. Grainger has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.