Here's Why D.R. Horton (NYSE:DHI) Can Manage Its Debt Responsibly

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 D.R. Horton, Inc. (NYSE:DHI) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for D.R. Horton

How Much Debt Does D.R. Horton Carry?

The image below, which you can click on for greater detail, shows that D.R. Horton had debt of US$5.71b at the end of June 2024, a reduction from US$6.12b over a year. However, because it has a cash reserve of US$2.69b, its net debt is less, at about US$3.03b.

A Look At D.R. Horton's Liabilities

Zooming in on the latest balance sheet data, we can see that D.R. Horton had liabilities of US$5.26b due within 12 months and liabilities of US$4.74b due beyond that. Offsetting this, it had US$2.69b in cash and US$320.1m in receivables that were due within 12 months. So it has liabilities totalling US$6.99b more than its cash and near-term receivables, combined.

Given D.R. Horton has a humongous market capitalization of US$56.6b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

D.R. Horton's net debt is only 0.46 times its EBITDA. And its EBIT easily covers its interest expense, being 1k times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. While D.R. Horton doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if D.R. Horton 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, D.R. Horton's free cash flow amounted to 26% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, D.R. Horton's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that D.R. Horton can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. We'd be motivated to research the stock further if we found out that D.R. Horton insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.