Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ 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. As with many other companies TopBuild Corp. (NYSE:BLD) makes use of debt. But the real question is whether this debt is making the company risky.
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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for TopBuild
How Much Debt Does TopBuild Carry?
The image below, which you can click on for greater detail, shows that at September 2022 TopBuild had debt of US$1.47b, up from US$699.1m in one year. However, it also had US$159.4m in cash, and so its net debt is US$1.31b.
A Look At TopBuild’s Liabilities
The latest balance sheet data shows that TopBuild had liabilities of US$788.6m due within a year, and liabilities of US$1.88b falling due after that. On the other hand, it had cash of US$159.4m and US$815.6m worth of receivables due within a year. So it has liabilities totalling US$1.70b more than its cash and near-term receivables, combined.
This deficit isn’t so bad because TopBuild is worth US$5.33b, 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
We’d say that TopBuild’s moderate net debt to EBITDA ratio ( being 1.5), indicates prudence when it comes to debt. And its commanding EBIT of 14.3 times its interest expense, implies the debt load is as light as a peacock feather. In addition to that, we’re happy to report that TopBuild has boosted its EBIT by 56%, thus reducing the spectre of future debt repayments. 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 TopBuild 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, TopBuild produced sturdy free cash flow equating to 67% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
Happily, TopBuild’s impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Looking at the bigger picture, we think TopBuild’s use of debt seems quite reasonable and we’re not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return 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. For example, we’ve discovered 2 warning signs for TopBuild (1 is potentially serious!) that you should be aware of before investing here.
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.
What are the risks and opportunities for TopBuild?
Price-To-Earnings ratio (10.9x) is below the US market (14.5x)
Earnings grew by 55% over the past year
Earnings are forecast to decline by an average of 9.2% per year for the next 3 years
Has a high level of debt
View all Risks and Rewards
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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.