Green Brick Partners (NYSE:GRBK) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Green Brick Partners, Inc. (NYSE:GRBK) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Green Brick Partners

How Much Debt Does Green Brick Partners Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Green Brick Partners had US$384.9m of debt, an increase on US$366.5m, over one year. However, because it has a cash reserve of US$66.8m, its net debt is less, at about US$318.2m.

How Strong Is Green Brick Partners' Balance Sheet?

According to the last reported balance sheet, Green Brick Partners had liabilities of US$214.3m due within 12 months, and liabilities of US$388.4m due beyond 12 months. On the other hand, it had cash of US$66.8m and US$6.83m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$529.2m.

While this might seem like a lot, it is not so bad since Green Brick Partners has a market capitalization of US$1.22b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Green Brick Partners's net debt is only 0.95 times its EBITDA. And its EBIT covers its interest expense a whopping 1k times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Green Brick Partners grew its EBIT by 97% over the last twelve months, and that growth will make it easier to handle its debt. 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 Green Brick Partners'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, Green Brick Partners actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Green Brick Partners's interest cover was a real positive on this analysis, as was its EBIT growth rate. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. Considering this range of data points, we think Green Brick Partners is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. We've identified 1 warning sign with Green Brick Partners , and understanding them should be part of your investment process.

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.