Stock Analysis

PPG Industries (NYSE:PPG) Seems To Use Debt Quite Sensibly

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NYSE:PPG
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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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that PPG Industries, Inc. (NYSE:PPG) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

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How Much Debt Does PPG Industries Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 PPG Industries had US$7.15b of debt, an increase on US$6.29b, over one year. However, because it has a cash reserve of US$1.31b, its net debt is less, at about US$5.84b.

debt-equity-history-analysis
NYSE:PPG Debt to Equity History August 30th 2021

A Look At PPG Industries' Liabilities

The latest balance sheet data shows that PPG Industries had liabilities of US$5.49b due within a year, and liabilities of US$10.5b falling due after that. Offsetting this, it had US$1.31b in cash and US$3.50b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$11.1b.

While this might seem like a lot, it is not so bad since PPG Industries has a huge market capitalization of US$38.4b, 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 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).

PPG Industries's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its commanding EBIT of 19.5 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, PPG Industries grew its EBIT by 38% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if PPG Industries 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, PPG Industries recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, PPG Industries's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Zooming out, PPG Industries seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. We've identified 1 warning sign with PPG Industries , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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What are the risks and opportunities for PPG Industries?

PPG Industries, Inc. manufactures and distributes paints, coatings, and specialty materials worldwide.

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Rewards

  • Trading at 5.6% below our estimate of its fair value

  • Earnings are forecast to grow 15.37% per year

Risks

  • Debt is not well covered by operating cash flow

  • Profit margins (5.8%) are lower than last year (8.5%)

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