Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Fox Factory Holding Corp. (NASDAQ:FOXF) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Fox Factory Holding
How Much Debt Does Fox Factory Holding Carry?
The image below, which you can click on for greater detail, shows that at September 2019 Fox Factory Holding had debt of US$73.0m, up from US$59.4 in one year. However, it does have US$32.0m in cash offsetting this, leading to net debt of about US$41.0m.
How Strong Is Fox Factory Holding’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Fox Factory Holding had liabilities of US$102.6m due within 12 months and liabilities of US$85.6m due beyond that. Offsetting this, it had US$32.0m in cash and US$106.8m in receivables that were due within 12 months. So its liabilities total US$49.5m more than the combination of its cash and short-term receivables.
Having regard to Fox Factory Holding’s size, it seems that its liquid assets are well balanced with its total liabilities. So it’s very unlikely that the US$2.74b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Fox Factory Holding has a very light debt load indeed.
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.
Fox Factory Holding’s net debt is only 0.32 times its EBITDA. And its EBIT covers its interest expense a whopping 33.9 times over. So we’re pretty relaxed about its super-conservative use of debt. Another good sign is that Fox Factory Holding has been able to increase its EBIT by 25% in twelve months, making it easier to pay down 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 Fox Factory Holding 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Fox Factory Holding’s free cash flow amounted to 36% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
Our View
Fox Factory Holding’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Looking at the bigger picture, we think Fox Factory Holding’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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we’ve discovered 1 warning sign for Fox Factory Holding that you should be aware of before investing here.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at [email protected]. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
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