We Think Genuine Parts (NYSE:GPC) Can Stay On Top Of Its Debt

By
Simply Wall St
Published
January 19, 2022
NYSE:GPC
Source: Shutterstock

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Genuine Parts Company (NYSE:GPC) 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 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.

See our latest analysis for Genuine Parts

What Is Genuine Parts's Debt?

As you can see below, Genuine Parts had US$2.43b of debt at September 2021, down from US$2.91b a year prior. However, it also had US$919.1m in cash, and so its net debt is US$1.51b.

debt-equity-history-analysis
NYSE:GPC Debt to Equity History January 19th 2022

How Healthy Is Genuine Parts' Balance Sheet?

We can see from the most recent balance sheet that Genuine Parts had liabilities of US$6.54b falling due within a year, and liabilities of US$4.24b due beyond that. Offsetting this, it had US$919.1m in cash and US$1.89b in receivables that were due within 12 months. So it has liabilities totalling US$7.97b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Genuine Parts has a huge market capitalization of US$19.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Genuine Parts has a low net debt to EBITDA ratio of only 1.0. And its EBIT covers its interest expense a whopping 17.2 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Genuine Parts grew its EBIT by 16% last year, making its debt load easier to handle. 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 Genuine Parts'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Genuine Parts actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Genuine Parts'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 the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Zooming out, Genuine Parts seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns 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 Genuine Parts , 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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