Here's Why Simpson Manufacturing (NYSE:SSD) Can Manage Its Debt Responsibly

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.' 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. We can see that Simpson Manufacturing Co., Inc. (NYSE:SSD) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Simpson Manufacturing

What Is Simpson Manufacturing's Debt?

You can click the graphic below for the historical numbers, but it shows that Simpson Manufacturing had US$561.6m of debt in September 2023, down from US$682.7m, one year before. However, its balance sheet shows it holds US$571.0m in cash, so it actually has US$9.43m net cash.

A Look At Simpson Manufacturing's Liabilities

According to the last reported balance sheet, Simpson Manufacturing had liabilities of US$427.6m due within 12 months, and liabilities of US$718.4m due beyond 12 months. Offsetting these obligations, it had cash of US$571.0m as well as receivables valued at US$351.2m due within 12 months. So its liabilities total US$223.8m more than the combination of its cash and short-term receivables.

Since publicly traded Simpson Manufacturing shares are worth a total of US$7.77b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Simpson Manufacturing also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Simpson Manufacturing has increased its EBIT by 2.4% over twelve months, which should ease any concerns about debt repayment. 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 Simpson Manufacturing'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Simpson Manufacturing 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. During the last three years, Simpson Manufacturing produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Simpson Manufacturing's liabilities, but we can be reassured by the fact it has has net cash of US$9.43m. So we don't think Simpson Manufacturing's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Simpson Manufacturing insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.