Here's Why Patterson Companies (NASDAQ:PDCO) Can Manage Its Debt Responsibly

By
Simply Wall St
Published
November 16, 2021
NasdaqGS:PDCO
Source: Shutterstock

Warren Buffett famously said, '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. As with many other companies Patterson Companies, Inc. (NASDAQ:PDCO) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Patterson Companies

What Is Patterson Companies's Net Debt?

The image below, which you can click on for greater detail, shows that Patterson Companies had debt of US$640.2m at the end of July 2021, a reduction from US$742.2m over a year. On the flip side, it has US$137.1m in cash leading to net debt of about US$503.1m.

debt-equity-history-analysis
NasdaqGS:PDCO Debt to Equity History November 17th 2021

How Strong Is Patterson Companies' Balance Sheet?

According to the last reported balance sheet, Patterson Companies had liabilities of US$1.07b due within 12 months, and liabilities of US$702.4m due beyond 12 months. On the other hand, it had cash of US$137.1m and US$588.0m worth of receivables due within a year. So its liabilities total US$1.05b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Patterson Companies has a market capitalization of US$3.30b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Patterson Companies's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its commanding EBIT of 22.5 times its interest expense, implies the debt load is as light as a peacock feather. Also good is that Patterson Companies grew its EBIT at 14% over the last year, further increasing its ability to manage 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 Patterson Companies's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Patterson Companies burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Patterson Companies's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. It's also worth noting that Patterson Companies is in the Healthcare industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about Patterson Companies's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 3 warning signs for Patterson Companies you should be aware of, and 2 of them are a bit unpleasant.

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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