In analyzing the riskiness of a company, it’s important to consider its balance sheet and the level of debt it carries. Debt becomes a concern when a company is unable to meet its obligations, either by generating enough free cash flow or raising capital at a reasonable cost. If matters worsen, lenders may take control of the business. However, the upside of debt is that it can provide cheap capital and allow for reinvestment at high rates of return.
Ferguson plc (NYSE: FERG), a company in question, has debt on its balance sheet. As of April 2023, it had a total debt of US$3.89 billion, an increase from the previous year. However, it also had US$625.0 million in cash, resulting in a net debt of approximately US$3.27 billion. While Ferguson has significant liabilities due within the next year, it does have enough worth to potentially raise capital if needed.
An important factor to assess a company’s debt is its ability to repay it. By considering its earnings before interest, tax, depreciation, and amortization (EBITDA) and its interest expense, we can gauge its net debt-to-EBITDA ratio and interest coverage. In the case of Ferguson, its net debt is only 1.0 times its EBITDA, and its EBIT easily covers its interest expense 16.1 times over. These figures suggest that Ferguson has a conservative approach to debt and is capable of servicing it.
Furthermore, Ferguson has experienced a 6.1% increase in EBIT over the past year, which should alleviate concerns about debt repayment. It has also generated steady free cash flow, with an average of 58% of its EBIT over the last three years, demonstrating its ability to reduce debt when necessary.
While debt carries inherent risks, Ferguson appears to manage it sensibly. Its strong interest coverage and net debt-to-EBITDA ratio support this observation. However, it’s important to note that every company carries risks outside of its balance sheet. It is advisable to be aware of potential warning signs and conduct a comprehensive analysis before making investment decisions.
[Source: Simply Wall St]