NVR (NYSE:NVR) Could Easily Take On More Debt

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. We note that NVR, Inc. (NYSE:NVR) does have debt on its balance sheet. 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 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for NVR

What Is NVR's Debt?

The chart below, which you can click on for greater detail, shows that NVR had US$1.52b in debt in December 2021; about the same as the year before. But it also has US$2.55b in cash to offset that, meaning it has US$1.03b 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$788.8m due within 12 months and liabilities of US$2.04b due beyond that. On the other hand, it had cash of US$2.55b and US$43.8m worth of receivables due within a year. So its liabilities total US$243.3m more than the combination of its cash and short-term receivables.

This state of affairs indicates that NVR's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$16.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, NVR boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, NVR grew its EBIT by 47% 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 ultimately the future profitability of the business will decide if NVR 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. NVR 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. During the last three years, NVR produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

We could understand if investors are concerned about NVR's liabilities, but we can be reassured by the fact it has has net cash of US$1.03b. And it impressed us with its EBIT growth of 47% over the last year. So is NVR'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 NVR's earnings per share history for free.

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.