Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Cavco Industries, Inc. (NASDAQ:CVCO) does use debt in its business. But should shareholders be worried about its use of debt?
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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Cavco Industries's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Cavco Industries had US$11.9m of debt in April 2021, down from US$14.6m, one year before. But it also has US$341.8m in cash to offset that, meaning it has US$329.9m net cash.
How Strong Is Cavco Industries' Balance Sheet?
The latest balance sheet data shows that Cavco Industries had liabilities of US$237.1m due within a year, and liabilities of US$31.1m falling due after that. On the other hand, it had cash of US$341.8m and US$47.4m worth of receivables due within a year. So it actually has US$121.0m more liquid assets than total liabilities.
This surplus suggests that Cavco Industries has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Cavco Industries has more cash than debt is arguably a good indication that it can manage its debt safely.
Fortunately, Cavco Industries grew its EBIT by 6.0% in the last year, making that debt load look even more manageable. 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 Cavco Industries'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. Cavco Industries 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 last three years, Cavco Industries recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case Cavco Industries has US$329.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in US$88m. So is Cavco Industries's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Cavco Industries's earnings per share history for free.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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