Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Quanex Building Products Corporation (NYSE:NX) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Quanex Building Products's Net Debt?
The image below, which you can click on for greater detail, shows that Quanex Building Products had debt of US$37.5m at the end of October 2021, a reduction from US$102.2m over a year. But on the other hand it also has US$40.1m in cash, leading to a US$2.57m net cash position.
How Strong Is Quanex Building Products' Balance Sheet?
The latest balance sheet data shows that Quanex Building Products had liabilities of US$158.0m due within a year, and liabilities of US$139.5m falling due after that. Offsetting this, it had US$40.1m in cash and US$108.3m in receivables that were due within 12 months. So its liabilities total US$149.2m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Quanex Building Products has a market capitalization of US$741.9m, 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. Despite its noteworthy liabilities, Quanex Building Products boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Quanex Building Products has boosted its EBIT by 47%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Quanex Building Products'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Quanex Building Products 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. Happily for any shareholders, Quanex Building Products actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While Quanex Building Products does have more liabilities than liquid assets, it also has net cash of US$2.57m. And it impressed us with free cash flow of US$55m, being 107% of its EBIT. So we don't think Quanex Building Products's use of debt is risky. Another factor that would give us confidence in Quanex Building Products 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.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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.