Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies MarineMax, Inc. (NYSE:HZO) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is MarineMax’s Debt?

You can click the graphic below for the historical numbers, but it shows that MarineMax had US$54.5m of debt in June 2021, down from US$147.0m, one year before. However, its balance sheet shows it holds US$200.1m in cash, so it actually has US$145.6m net cash.

A Look At MarineMax’s Liabilities

We can see from the most recent balance sheet that MarineMax had liabilities of US$221.6m falling due within a year, and liabilities of US$161.7m due beyond that. Offsetting these obligations, it had cash of US$200.1m as well as receivables valued at US$67.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$116.2m.

Of course, MarineMax has a market capitalization of US$1.11b, 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. While it does have liabilities worth noting, MarineMax also has more cash than debt, so we’re pretty confident it can manage its debt safely.

Better yet, MarineMax grew its EBIT by 123% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MarineMax’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. MarineMax may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, MarineMax actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although MarineMax’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$145.6m. And it impressed us with free cash flow of US$390m, being 166% of its EBIT. So we don’t think MarineMax’s use of debt is risky.