Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ 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. As with many other companies Cavco Industries, Inc. (NASDAQ:CVCO) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Cavco Industries’s Net Debt?
As you can see below, Cavco Industries had US$5.50m of debt at January 2022, down from US$12.7m a year prior. However, it does have US$288.4m in cash offsetting this, leading to net cash of US$282.9m.
How Strong Is Cavco Industries’ Balance Sheet?
We can see from the most recent balance sheet that Cavco Industries had liabilities of US$272.8m falling due within a year, and liabilities of US$32.1m due beyond that. Offsetting this, it had US$288.4m in cash and US$64.5m in receivables that were due within 12 months. So it actually has US$48.1m more liquid assets than total liabilities.
This short term liquidity is a sign that Cavco Industries could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Cavco Industries boasts net cash, so it’s fair to say it does not have a heavy debt load!
Even more impressive was the fact that Cavco Industries grew its EBIT by 111% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Cavco Industries 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. Cavco Industries 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. Over the last three years, Cavco Industries recorded free cash flow worth a fulsome 93% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Cavco Industries has net cash of US$282.9m, as well as more liquid assets than liabilities. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in US$120m. So we don’t think Cavco Industries’s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. To that end, you should be aware of the 1 warning sign we’ve spotted with Cavco Industries .
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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