Stock Analysis

These 4 Measures Indicate That Arrow Electronics (NYSE:ARW) Is Using Debt Reasonably Well

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NYSE:ARW
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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 Arrow Electronics, Inc. (NYSE:ARW) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

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How Much Debt Does Arrow Electronics Carry?

You can click the graphic below for the historical numbers, but it shows that as of July 2022 Arrow Electronics had US$3.48b of debt, an increase on US$2.24b, over one year. However, it also had US$225.6m in cash, and so its net debt is US$3.26b.

debt-equity-history-analysis
NYSE:ARW Debt to Equity History September 26th 2022

How Strong Is Arrow Electronics' Balance Sheet?

We can see from the most recent balance sheet that Arrow Electronics had liabilities of US$11.0b falling due within a year, and liabilities of US$3.46b due beyond that. Offsetting this, it had US$225.6m in cash and US$10.9b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.42b.

Arrow Electronics has a market capitalization of US$5.99b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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).

We'd say that Arrow Electronics's moderate net debt to EBITDA ratio ( being 1.5), indicates prudence when it comes to debt. And its strong interest cover of 17.7 times, makes us even more comfortable. In addition to that, we're happy to report that Arrow Electronics has boosted its EBIT by 63%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Arrow Electronics can strengthen its balance sheet over time. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Arrow Electronics recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Arrow Electronics's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Arrow Electronics can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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 instance, we've identified 3 warning signs for Arrow Electronics that 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.

Valuation is complex, but we're helping make it simple.

Find out whether Arrow Electronics is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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About NYSE:ARW

Arrow Electronics

Arrow Electronics, Inc. provides products, services, and solutions to industrial and commercial users of electronic components and enterprise computing solutions in the Americas, Europe, the Middle East, Africa, and the Asia Pacific.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation3
Future Growth0
Past Performance5
Financial Health3
Dividends0

Read more about these checks in the individual report sections or in our analysis model.

Solid track record and fair value.