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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Brady Corporation (NYSE:BRC) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Brady's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Brady had US$50.3m of debt in April 2019, down from US$58.2m, one year before. However, it does have US$238.4m in cash offsetting this, leading to net cash of US$188.1m.
How Strong Is Brady's Balance Sheet?
We can see from the most recent balance sheet that Brady had liabilities of US$177.9m falling due within a year, and liabilities of US$113.5m due beyond that. Offsetting this, it had US$238.4m in cash and US$162.1m in receivables that were due within 12 months. So it can boast US$109.2m more liquid assets than total liabilities.
This surplus suggests that Brady has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Brady boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Brady grew its EBIT at 12% over the last year, further increasing its ability to manage debt. 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 Brady 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. Brady may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Brady generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case Brady has US$188m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$126m, being 83% of its EBIT. So is Brady's debt a risk? It doesn't seem so to us. We'd be very excited to see if Brady insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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