These 4 Measures Indicate That SiteOne Landscape Supply (NYSE:SITE) Is Using Debt Reasonably Well

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.' 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, SiteOne Landscape Supply, Inc. (NYSE:SITE) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SiteOne Landscape Supply

What Is SiteOne Landscape Supply's Debt?

The image below, which you can click on for greater detail, shows that at October 2022 SiteOne Landscape Supply had debt of US$387.8m, up from US$324.8m in one year. However, because it has a cash reserve of US$70.0m, its net debt is less, at about US$317.8m.

How Healthy Is SiteOne Landscape Supply's Balance Sheet?

We can see from the most recent balance sheet that SiteOne Landscape Supply had liabilities of US$607.1m falling due within a year, and liabilities of US$702.0m due beyond that. Offsetting this, it had US$70.0m in cash and US$502.8m in receivables that were due within 12 months. So its liabilities total US$736.3m more than the combination of its cash and short-term receivables.

Given SiteOne Landscape Supply has a market capitalization of US$5.30b, it's hard to believe these liabilities pose much threat. 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.

SiteOne Landscape Supply has a low net debt to EBITDA ratio of only 0.69. And its EBIT easily covers its interest expense, being 18.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, SiteOne Landscape Supply grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if SiteOne Landscape Supply can strengthen its balance sheet over time. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, SiteOne Landscape Supply produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that SiteOne Landscape Supply's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, SiteOne Landscape Supply seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with SiteOne Landscape Supply .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.