David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ 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. We can see that Valmont Industries, Inc. (NYSE:VMI) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Valmont Industries’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2021 Valmont Industries had US$917.9m of debt, an increase on US$795.9m, over one year. However, it also had US$169.8m in cash, and so its net debt is US$748.1m.
How Strong Is Valmont Industries’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Valmont Industries had liabilities of US$751.0m due within 12 months and liabilities of US$1.32b due beyond that. On the other hand, it had cash of US$169.8m and US$693.1m worth of receivables due within a year. So it has liabilities totalling US$1.20b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Valmont Industries has a market capitalization of US$5.20b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Valmont Industries’s net debt of 1.8 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 8.0 times its interest expenses harmonizes with that theme. It is well worth noting that Valmont Industries’s EBIT shot up like bamboo after rain, gaining 31% in the last twelve months. That’ll make it easier to manage 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 Valmont Industries’s ability to maintain a healthy balance sheet going forward.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Valmont Industries recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
The good news is that Valmont Industries’s demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. And its interest cover is good too. When we consider the range of factors above, it looks like Valmont Industries is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There’s no doubt that we learn most about debt from the balance sheet.