Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Fox Factory Holding Corp. (NASDAQ:FOXF) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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.
What Is Fox Factory Holding’s Debt?
You can click the graphic below for the historical numbers, but it shows that Fox Factory Holding had US$388.5m of debt in July 2021, down from US$406.4m, one year before. However, it does have US$275.0m in cash offsetting this, leading to net debt of about US$113.5m.
A Look At Fox Factory Holding’s Liabilities
The latest balance sheet data shows that Fox Factory Holding had liabilities of US$248.9m due within a year, and liabilities of US$400.7m falling due after that. On the other hand, it had cash of US$275.0m and US$149.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$225.0m.
Of course, Fox Factory Holding has a market capitalization of US$6.20b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Fox Factory Holding has a low net debt to EBITDA ratio of only 0.51. And its EBIT easily covers its interest expense, being 20.5 times the size. So we’re pretty relaxed about its super-conservative use of debt. On top of that, Fox Factory Holding grew its EBIT by 79% over the last twelve months, and that growth will make it easier to handle its debt. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Fox Factory Holding’s ability to maintain a healthy balance sheet going forward.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Fox Factory Holding’s free cash flow amounted to 28% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
Happily, Fox Factory Holding’s impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Zooming out, Fox Factory Holding seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity.