MSC Industrial Direct (NYSE:MSM) Has A Pretty Healthy 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.' 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. As with many other companies MSC Industrial Direct Co., Inc. (NYSE:MSM) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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

What Is MSC Industrial Direct's Debt?

The chart below, which you can click on for greater detail, shows that MSC Industrial Direct had US$552.0m in debt in March 2024; about the same as the year before. On the flip side, it has US$22.2m in cash leading to net debt of about US$529.8m.

A Look At MSC Industrial Direct's Liabilities

Zooming in on the latest balance sheet data, we can see that MSC Industrial Direct had liabilities of US$630.4m due within 12 months and liabilities of US$467.5m due beyond that. Offsetting these obligations, it had cash of US$22.2m as well as receivables valued at US$428.7m due within 12 months. So it has liabilities totalling US$647.0m more than its cash and near-term receivables, combined.

Of course, MSC Industrial Direct has a market capitalization of US$5.12b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

MSC Industrial Direct's net debt is only 0.99 times its EBITDA. And its EBIT easily covers its interest expense, being 21.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that MSC Industrial Direct has seen its EBIT plunge 10% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 MSC Industrial Direct'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.

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, MSC Industrial Direct produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, MSC Industrial Direct's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its EBIT growth rate. Looking at all the aforementioned factors together, it strikes us that MSC Industrial Direct can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. We'd be motivated to research the stock further if we found out that MSC Industrial Direct insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.