Snap-on (NYSE:SNA) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Snap-on Incorporated (NYSE:SNA) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Snap-on

What Is Snap-on's Debt?

The chart below, which you can click on for greater detail, shows that Snap-on had US$1.20b in debt in September 2024; about the same as the year before. But on the other hand it also has US$1.31b in cash, leading to a US$113.6m net cash position.

A Look At Snap-on's Liabilities

We can see from the most recent balance sheet that Snap-on had liabilities of US$956.4m falling due within a year, and liabilities of US$1.50b due beyond that. On the other hand, it had cash of US$1.31b and US$800.5m worth of receivables due within a year. So its liabilities total US$341.9m more than the combination of its cash and short-term receivables.

Having regard to Snap-on's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$18.0b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Snap-on also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Snap-on grew its EBIT by 4.4% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Snap-on'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. Snap-on may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Snap-on recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Snap-on has US$113.6m in net cash. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in US$1.1b. So we don't think Snap-on's use of debt is risky. We'd be motivated to research the stock further if we found out that Snap-on 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.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.