Is Stanley Black & Decker (NYSE:SWK) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Stanley Black & Decker, Inc. (NYSE:SWK) does use debt in its business. But is this debt a concern to shareholders?

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. 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 think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that SWK is potentially undervalued!

How Much Debt Does Stanley Black & Decker Carry?

As you can see below, at the end of July 2022, Stanley Black & Decker had US$11.2b of debt, up from US$4.31b a year ago. Click the image for more detail. However, it also had US$282.3m in cash, and so its net debt is US$10.9b.

How Strong Is Stanley Black & Decker's Balance Sheet?

According to the last reported balance sheet, Stanley Black & Decker had liabilities of US$11.8b due within 12 months, and liabilities of US$8.52b due beyond 12 months. Offsetting this, it had US$282.3m in cash and US$1.59b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$18.4b.

This deficit casts a shadow over the US$11.4b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Stanley Black & Decker would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Stanley Black & Decker's debt to EBITDA ratio of 5.1 suggests a heavy debt load, its interest coverage of 7.4 implies it services that debt with ease. Our best guess is that the company does indeed have significant debt obligations. Importantly, Stanley Black & Decker's EBIT fell a jaw-dropping 37% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Stanley Black & Decker 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Stanley Black & Decker reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

To be frank both Stanley Black & Decker's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Taking into account all the aforementioned factors, it looks like Stanley Black & Decker has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Stanley Black & Decker (1 can't be ignored) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.