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. We can see that NVR, Inc. (NYSE:NVR) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is NVR's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2021 NVR had US$1.52b of debt, an increase on US$598.5m, over one year. But it also has US$2.75b in cash to offset that, meaning it has US$1.24b net cash.
How Strong Is NVR's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that NVR had liabilities of US$857.1m due within 12 months and liabilities of US$1.92b due beyond that. Offsetting these obligations, it had cash of US$2.75b as well as receivables valued at US$22.1m due within 12 months. So these liquid assets roughly match the total liabilities.
Having regard to NVR's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$17.5b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, NVR boasts net cash, so it's fair to say it does not have a heavy debt load!
Another good sign is that NVR has been able to increase its EBIT by 23% in twelve months, making it easier to pay down 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 NVR'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While NVR has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, NVR recorded free cash flow worth a fulsome 82% 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 NVR has US$1.24b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$1.2b, being 82% of its EBIT. So we don't think NVR's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for NVR 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.
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