We Think Thermon Group Holdings (NYSE:THR) Is Taking Some Risk With Its Debt

By
Simply Wall St
Published
June 02, 2021
NYSE:THR
Source: Shutterstock

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Thermon Group Holdings, Inc. (NYSE:THR) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Thermon Group Holdings

How Much Debt Does Thermon Group Holdings Carry?

As you can see below, Thermon Group Holdings had US$145.5m of debt at March 2021, down from US$171.6m a year prior. On the flip side, it has US$40.1m in cash leading to net debt of about US$105.4m.

debt-equity-history-analysis
NYSE:THR Debt to Equity History June 3rd 2021

How Healthy Is Thermon Group Holdings' Balance Sheet?

The latest balance sheet data shows that Thermon Group Holdings had liabilities of US$52.4m due within a year, and liabilities of US$186.3m falling due after that. Offsetting these obligations, it had cash of US$40.1m as well as receivables valued at US$94.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$104.5m.

Since publicly traded Thermon Group Holdings shares are worth a total of US$581.1m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Thermon Group Holdings's debt to EBITDA ratio (2.9) suggests that it uses some debt, its interest cover is very weak, at 1.6, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Thermon Group Holdings's EBIT was down 50% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Thermon Group Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Thermon Group Holdings generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Neither Thermon Group Holdings's ability to grow its EBIT nor its interest cover gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Thermon Group Holdings is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Thermon Group Holdings you should know about.

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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