David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Leggett & Platt, Incorporated (NYSE:LEG) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Leggett & Platt
How Much Debt Does Leggett & Platt Carry?
The chart below, which you can click on for greater detail, shows that Leggett & Platt had US$2.14b in debt in September 2022; about the same as the year before. However, it also had US$226.2m in cash, and so its net debt is US$1.91b.
How Healthy Is Leggett & Platt’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Leggett & Platt had liabilities of US$965.0m due within 12 months and liabilities of US$2.65b due beyond that. Offsetting these obligations, it had cash of US$226.2m as well as receivables valued at US$730.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.66b.
This deficit is considerable relative to its market capitalization of US$4.33b, so it does suggest shareholders should keep an eye on Leggett & Platt’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Leggett & Platt’s debt is 2.7 times its EBITDA, and its EBIT cover its interest expense 7.0 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. Unfortunately, Leggett & Platt saw its EBIT slide 2.3% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Leggett & Platt 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, 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, Leggett & Platt produced sturdy free cash flow equating to 69% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
On our analysis Leggett & Platt’s conversion of EBIT to free cash flow should signal that it won’t have too much trouble with its debt. But the other factors we noted above weren’t so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. Looking at all this data makes us feel a little cautious about Leggett & Platt’s debt levels. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we’ve spotted with Leggett & Platt .
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.
What are the risks and opportunities for Leggett & Platt?
Trading at 15.4% below our estimate of its fair value
Earnings are forecast to decline by an average of 0.01% per year for the next 3 years
Debt is not well covered by operating cash flow
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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.