Is MSC Industrial Direct (NYSE:MSM) A Risky Investment?

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.' 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 can see that MSC Industrial Direct Co., Inc. (NYSE:MSM) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for MSC Industrial Direct

How Much Debt Does MSC Industrial Direct Carry?

The image below, which you can click on for greater detail, shows that MSC Industrial Direct had debt of US$463.9m at the end of June 2023, a reduction from US$788.5m over a year. However, it does have US$58.4m in cash offsetting this, leading to net debt of about US$405.5m.

How Strong Is MSC Industrial Direct's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that MSC Industrial Direct had liabilities of US$683.5m due within 12 months and liabilities of US$340.7m due beyond that. Offsetting this, it had US$58.4m in cash and US$438.6m in receivables that were due within 12 months. So its liabilities total US$527.2m more than the combination of its cash and short-term receivables.

Since publicly traded MSC Industrial Direct shares are worth a total of US$5.34b, 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.

MSC Industrial Direct has a low net debt to EBITDA ratio of only 0.69. And its EBIT covers its interest expense a whopping 22.2 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that MSC Industrial Direct grew its EBIT by 17% last year, making its debt load easier to handle. 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 MSC Industrial Direct'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, MSC Industrial Direct recorded free cash flow worth 79% 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.

Our View

MSC Industrial Direct'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 MSC Industrial Direct is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. Another factor that would give us confidence in MSC Industrial Direct would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly 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.