Is Summit Materials (NYSE:SUM) A Risky Investment?

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.' 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 note that Summit Materials, Inc. (NYSE:SUM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Summit Materials

What Is Summit Materials's Debt?

You can click the graphic below for the historical numbers, but it shows that Summit Materials had US$1.60b of debt in January 2022, down from US$1.90b, one year before. On the flip side, it has US$381.0m in cash leading to net debt of about US$1.22b.

How Strong Is Summit Materials' Balance Sheet?

We can see from the most recent balance sheet that Summit Materials had liabilities of US$309.1m falling due within a year, and liabilities of US$2.11b due beyond that. On the other hand, it had cash of US$381.0m and US$294.8m worth of receivables due within a year. So it has liabilities totalling US$1.74b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Summit Materials is worth US$3.70b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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.

Summit Materials has a debt to EBITDA ratio of 2.5 and its EBIT covered its interest expense 2.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. If Summit Materials can keep growing EBIT at last year's rate of 15% over the last year, then it will find its debt load easier to manage. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Summit Materials 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Summit Materials recorded free cash flow worth a fulsome 80% 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

On our analysis Summit Materials's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. To be specific, it seems about as good at covering its interest expense with its EBIT as wet socks are at keeping your feet warm. Considering this range of data points, we think Summit Materials is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Summit Materials (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.