Stock Analysis

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

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NYSE:PPG
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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, PPG Industries, Inc. (NYSE:PPG) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

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What Is PPG Industries's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 PPG Industries had US$6.57b of debt, an increase on US$5.74b, over one year. On the flip side, it has US$1.08b in cash leading to net debt of about US$5.49b.

debt-equity-history-analysis
NYSE:PPG Debt to Equity History March 9th 2022

How Strong Is PPG Industries' Balance Sheet?

According to the last reported balance sheet, PPG Industries had liabilities of US$4.77b due within 12 months, and liabilities of US$10.2b due beyond 12 months. Offsetting these obligations, it had cash of US$1.08b as well as receivables valued at US$3.15b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$10.7b.

This deficit isn't so bad because PPG Industries is worth a massive US$27.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

PPG Industries's net debt to EBITDA ratio of about 2.4 suggests only moderate use of debt. And its strong interest cover of 18.6 times, makes us even more comfortable. We saw PPG Industries grow its EBIT by 6.9% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PPG Industries'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, PPG Industries generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

PPG Industries'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 that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. When we consider the range of factors above, it looks like PPG Industries is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with PPG Industries .

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.

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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