Here's Why Worthington Industries (NYSE:WOR) Has A Meaningful Debt Burden

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Worthington Industries, Inc. (NYSE:WOR) does use debt in its business. But is this debt a concern to shareholders?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Worthington Industries

How Much Debt Does Worthington Industries Carry?

As you can see below, Worthington Industries had US$698.6m of debt, at November 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$129.6m in cash offsetting this, leading to net debt of about US$569.0m.

How Healthy Is Worthington Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Worthington Industries had liabilities of US$660.9m due within 12 months and liabilities of US$1.09b due beyond that. Offsetting this, it had US$129.6m in cash and US$709.7m in receivables that were due within 12 months. So its liabilities total US$912.0m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Worthington Industries has a market capitalization of US$3.00b, 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).

Worthington Industries's net debt is sitting at a very reasonable 2.0 times its EBITDA, while its EBIT covered its interest expense just 5.1 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Worthington Industries's EBIT fell a jaw-dropping 60% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Worthington 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Worthington Industries recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Worthington Industries's struggle to grow its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to convert EBIT to free cash flow isn't too shabby at all. We think that Worthington Industries's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Worthington Industries has 1 warning sign we think you should be aware of.

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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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.