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 Mueller Industries, Inc. (NYSE:MLI) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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 Mueller Industries’s Net Debt?
The image below, which you can click on for greater detail, shows that at June 2021 Mueller Industries had debt of US$357.4m, up from US$329.7m in one year. On the flip side, it has US$110.7m in cash leading to net debt of about US$246.7m.
How Healthy Is Mueller Industries’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Mueller Industries had liabilities of US$362.4m due within 12 months and liabilities of US$453.1m due beyond that. On the other hand, it had cash of US$110.7m and US$542.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$162.8m.
Given Mueller Industries has a market capitalization of US$2.43b, it’s hard to believe these liabilities pose much threat. 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). 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).
Mueller Industries’s net debt is only 0.57 times its EBITDA. And its EBIT covers its interest expense a whopping 27.3 times over. So we’re pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Mueller Industries grew its EBIT by 105% over twelve months. 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 Mueller Industries’s ability to maintain a healthy balance sheet going forward.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Mueller Industries recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Our View
Mueller Industries’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. And that’s just the beginning of the good news since its EBIT growth rate is also very heartening. Overall, we don’t think Mueller Industries is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us.