Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Above all, Strattec Security Company (NASDAQ: STRT) is in debt. But the real question is whether this debt makes the business risky.
When is Debt a Problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first look at cash and debt levels, together.
What is Strattec Security’s debt?
You can click on the graph below for historical numbers, but it shows that Strattec Security had $ 17.0 million in debt as of September 2021, down from $ 30 million a year earlier. However, it has $ 7.02 million in cash offsetting that, which leads to net debt of around $ 9.98 million.
NasdaqGM: STRT History of debt to equity December 20, 2021
How healthy is Strattec Security’s track record?
Zooming in on the latest balance sheet data, we can see that Strattec Security had liabilities of US $ 70.4 million due within 12 months and US $ 24.5 million liabilities beyond. In return, he had $ 7.02 million in cash and $ 66.6 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 21.3 million.
Given that Strattec Security’s publicly traded shares are worth a total of US $ 145.5 million, it seems unlikely that this level of liabilities is a major threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we look at debt versus earnings with and without amortization expenses.
Strattec Security’s net debt is only 0.23 times its EBITDA. And its EBIT covers its interest costs 95.2 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. It was also good to see that despite losing money on the EBIT line last year, Strattec Security has been a game-changer over the past 12 months, delivering EBIT of US $ 23 million. When analyzing debt levels, the balance sheet is the obvious place to start. But it is future profits, more than anything, that will determine Strattec Security’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent profit before interest and taxes (EBIT) is supported by free cash flow. Over the past year, Strattec Security’s free cash flow has been 35% of its EBIT, less than we expected. This low cash conversion makes debt management more difficult.
Our point of view
The good news is that Strattec Security’s demonstrated ability to cover interest costs with its BAII delights us like a fluffy puppy does a toddler. But frankly, we think its conversion from EBIT to free cash flow undermines that impression a bit. All these things considered, it looks like Strattec Security can comfortably manage its current debt levels. Of course, while this leverage can improve returns on equity, it comes with more risk, so it’s worth keeping an eye out for. When analyzing debt levels, the balance sheet is the obvious place to start. But at the end of the day, every business can contain risks that exist off the balance sheet. Note that Strattec Security displays 2 warning signs in our investment analysis , you must know…
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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