Polaris (NYSE:PII) Takes On Some Risk With Its Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Polaris Inc. (NYSE:PII) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Polaris

What Is Polaris's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Polaris had US$2.13b of debt, an increase on US$2.05b, over one year. However, because it has a cash reserve of US$327.5m, its net debt is less, at about US$1.81b.

How Healthy Is Polaris' Balance Sheet?

According to the last reported balance sheet, Polaris had liabilities of US$1.98b due within 12 months, and liabilities of US$2.39b due beyond 12 months. On the other hand, it had cash of US$327.5m and US$266.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.77b.

This deficit is considerable relative to its market capitalization of US$4.67b, so it does suggest shareholders should keep an eye on Polaris' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). 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).

Polaris's net debt is sitting at a very reasonable 2.3 times its EBITDA, while its EBIT covered its interest expense just 3.8 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Polaris's EBIT fell a jaw-dropping 42% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Polaris'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Polaris's free cash flow amounted to 25% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Polaris's EBIT growth rate was disappointing. Having said that, its ability handle its debt, based on its EBITDA, isn't such a worry. We're quite clear that we consider Polaris to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. For example, we've discovered 2 warning signs for Polaris that you should be aware of before investing here.

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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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.