We Think Tri Pointe Homes (NYSE:TPH) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Tri Pointe Homes, Inc. (NYSE:TPH) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Tri Pointe Homes

How Much Debt Does Tri Pointe Homes Carry?

As you can see below, Tri Pointe Homes had US$997.7m of debt at September 2024, down from US$1.38b a year prior. However, because it has a cash reserve of US$676.0m, its net debt is less, at about US$321.7m.

A Look At Tri Pointe Homes' Liabilities

According to the last reported balance sheet, Tri Pointe Homes had liabilities of US$372.9m due within 12 months, and liabilities of US$1.16b due beyond 12 months. On the other hand, it had cash of US$676.0m and US$88.1m worth of receivables due within a year. So its liabilities total US$765.3m more than the combination of its cash and short-term receivables.

Since publicly traded Tri Pointe Homes shares are worth a total of US$3.88b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Tri Pointe Homes has a low net debt to EBITDA ratio of only 0.52. 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. Fortunately, Tri Pointe Homes grew its EBIT by 7.6% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Tri Pointe Homes 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Tri Pointe Homes produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Tri Pointe Homes's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Taking all this data into account, it seems to us that Tri Pointe Homes takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Tri Pointe Homes that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.