Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, The Toro Company (NYSE:TTC) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Toro Carry?
As you can see below, Toro had US$691.6m of debt at July 2021, down from US$890.9m a year prior. On the flip side, it has US$535.3m in cash leading to net debt of about US$156.2m.
How Strong Is Toro's Balance Sheet?
We can see from the most recent balance sheet that Toro had liabilities of US$958.4m falling due within a year, and liabilities of US$772.4m due beyond that. Offsetting these obligations, it had cash of US$535.3m as well as receivables valued at US$301.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$894.3m.
Since publicly traded Toro shares are worth a very impressive total of US$10.5b, 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. But either way, Toro has virtually no net debt, so it's fair to say it does not have a heavy debt load!
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Toro has a low net debt to EBITDA ratio of only 0.25. And its EBIT easily covers its interest expense, being 18.5 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Toro grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Toro can strengthen its balance sheet over time. 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Toro generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Toro's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. We think Toro is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming. 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 1 warning sign for Toro that you should be aware of.
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.
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.
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