Patterson Companies (NASDAQ:PDCO) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Patterson Companies, Inc. (NASDAQ:PDCO) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Patterson Companies

How Much Debt Does Patterson Companies Carry?

As you can see below, Patterson Companies had US$642.0m of debt, at July 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$153.2m, its net debt is less, at about US$488.8m.

How Healthy Is Patterson Companies' Balance Sheet?

We can see from the most recent balance sheet that Patterson Companies had liabilities of US$1.04b falling due within a year, and liabilities of US$687.8m due beyond that. Offsetting this, it had US$153.2m in cash and US$589.6m in receivables that were due within 12 months. So it has liabilities totalling US$988.5m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Patterson Companies has a market capitalization of US$2.39b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Patterson Companies's moderate net debt to EBITDA ratio ( being 1.5), indicates prudence when it comes to debt. And its strong interest cover of 1k times, makes us even more comfortable. On top of that, Patterson Companies grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. 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 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Patterson Companies burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far 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. We would also note that Healthcare industry companies like Patterson Companies commonly do use debt without problems. Considering this range of data points, we think Patterson Companies is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. We've identified 3 warning signs with Patterson Companies (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

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.