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.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Louisiana-Pacific Corporation (NYSE:LPX) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Louisiana-Pacific’s Net Debt?

As you can see below, Louisiana-Pacific had US$337.0m of debt at March 2021, down from US$697.0m a year prior. But on the other hand it also has US$645.0m in cash, leading to a US$308.0m net cash position.

How Strong Is Louisiana-Pacific’s Balance Sheet?

The latest balance sheet data shows that Louisiana-Pacific had liabilities of US$360.0m due within a year, and liabilities of US$570.0m falling due after that. On the other hand, it had cash of US$645.0m and US$264.0m worth of receivables due within a year. So it has liabilities totalling US$21.0m more than its cash and near-term receivables, combined.

This state of affairs indicates that Louisiana-Pacific’s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it’s hard to imagine that the US$5.67b company is struggling for cash, we still think it’s worth monitoring its balance sheet. While it does have liabilities worth noting, Louisiana-Pacific also has more cash than debt, so we’re pretty confident it can manage its debt safely.

Better yet, Louisiana-Pacific grew its EBIT by 944% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Louisiana-Pacific can strengthen its balance sheet over time.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Louisiana-Pacific has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Louisiana-Pacific produced sturdy free cash flow equating to 74% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company’s total liabilities, it is very reassuring that Louisiana-Pacific has US$308.0m in net cash. And we liked the look of last year’s 944% year-on-year EBIT growth. So is Louisiana-Pacific’s debt a risk? It doesn’t seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt.