Does Frontdoor (NASDAQ:FTDR) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Frontdoor, Inc. (NASDAQ:FTDR) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Frontdoor

What Is Frontdoor's Debt?

The chart below, which you can click on for greater detail, shows that Frontdoor had US$582.0m in debt in September 2024; about the same as the year before. However, it also had US$378.0m in cash, and so its net debt is US$204.0m.

How Healthy Is Frontdoor's Balance Sheet?

According to the last reported balance sheet, Frontdoor had liabilities of US$341.0m due within 12 months, and liabilities of US$615.0m due beyond 12 months. Offsetting this, it had US$378.0m in cash and US$81.0m in receivables that were due within 12 months. So it has liabilities totalling US$497.0m more than its cash and near-term receivables, combined.

Given Frontdoor has a market capitalization of US$4.46b, it's hard to believe these liabilities pose much 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Frontdoor has a low net debt to EBITDA ratio of only 0.52. And its EBIT easily covers its interest expense, being 17.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Frontdoor has boosted its EBIT by 38%, thus reducing the spectre of future debt repayments. 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 Frontdoor 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Frontdoor recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Frontdoor's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Considering this range of factors, it seems to us that Frontdoor is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Frontdoor you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.