We believe Summit Materials (NYSE: SUM) can stay on top of its debt
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of 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, Summit Materials, Inc. (NYSE: SUM) carries debt. But the most important question is: what risk does this debt create?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest analysis for Summit Materials
What is Summit Materials’ net debt?
The graph below, which you can click for more details, shows that Summit Materials had $ 1.90 billion in debt as of July 2021; about the same as the year before. However, it has US $ 469.1 million in cash offsetting this, which leads to net debt of around US $ 1.43 billion.
How strong is Summit Materials’ balance sheet?
We can see from the most recent balance sheet that Summit Materials had liabilities of US $ 341.9 million maturing within one year and liabilities of US $ 2.42 billion maturing beyond that. . In compensation for these obligations, it had cash of US $ 469.1 million as well as receivables valued at US $ 345.3 million within 12 months. It therefore has liabilities totaling US $ 1.94 billion more than its cash and short-term receivables combined.
This deficit is not that big as Summit Materials is worth US $ 3.73 billion, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
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 profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
While Summit Materials’ debt-to-EBITDA ratio (3.0) suggests it is using some debt, its interest coverage is very low at 2.4, suggesting high leverage. It appears the company incurs significant depreciation and amortization costs, so perhaps its debt load is heavier than it first appears, since EBITDA is arguably a generous measure of profits. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. Notably, Summit Materials’ EBIT has been fairly stable over the past year, which is not ideal given the leverage. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Summit Materials’ ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Summit Materials has recorded free cash flow of 78% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
When it comes to the balance sheet, the bright spot for Summit Materials was that it appears to be able to convert EBIT to free cash flow with confidence. However, our other observations were not so encouraging. To be precise, it seems about as good at covering its interest costs with its EBIT as wet socks are at keeping your feet warm. When we consider all of the factors mentioned above, we feel a little cautious about Summit Materials’ use of debt. While debt has its advantage in terms of potential higher returns, we think shareholders should definitely consider how leverage levels might make the stock riskier. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. Note that Summit Materials displays 4 warning signs in our investment analysis , and 1 of them makes us a little uncomfortable …
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
If you decide to trade Summit materials, use the cheapest platform * which is ranked # 1 overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, currencies, bonds and funds in 135 markets, all from one integrated account. Promoted
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Online Annual Review 2020
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.