Howard Marks put it very well when he said that instead of worrying about stock price volatility, “the possibility of permanent loss is the risk that concerns me…and that concerns every practical investor I know.” . When we think of a company’s risk, we always like to look at its use of debt, as debt overload can lead to ruin. bombastic, mohawk industries, inc. (NYSE:MHK) has debt. But should shareholders be concerned about their use of debt?
Why does debt bring risk?
Generally speaking, debt only becomes a real problem when a business cannot easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company is unable to meet its legal obligations to repay the debt, the shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company must dilute shareholders at a cheap share price simply to control debt. However, by replacing dilution, debt can be an extremely good tool for companies that need capital to invest in growth with high rates of return. The first thing to do when considering how much debt a business uses is to look at your cash and debt together.
See our latest review of Mohawk Industries
What is Mohawk Industries’ debt?
You can click on the chart below to see the historical numbers, but it shows that Mohawk Industries had US$2.50 billion in debt as of July 2022, down from US$2.63 billion the year before. However, it has $489.0 million in cash to offset this, leading to a net debt of around $2.01 trillion.
A look at Mohawk Industries’ responsibilities
According to the last reported balance sheet, Mohawk Industries had liabilities of US$3.92b due within 12 months and liabilities of US$2.16b due in more than 12 months. To offset this, he had $489 million in cash and $2.11 billion in accounts receivable that were due within 12 months. Therefore, it has liabilities totaling $3.49 billion more than its cash and short-term receivables combined.
Mohawk Industries has a market capitalization of $6.74 billion, so it could very likely raise cash to improve its balance sheet, should the need arise. But we definitely want to keep our eyes open for indications that your debt is creating too much risk.
To assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its interest expense. (your interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio).
Mohawk Industries’ net debt is only 1.1 times its EBITDA. And its EBIT covers its interest expense a whopping 25.9 times. So we’re pretty cool about his super conservative use of debt. Mohawk Industries’ EBIT was pretty flat over the last year, but that shouldn’t be a problem given that it doesn’t have a lot of debt. There is no doubt that we learn more about debt from the balance sheet. But it is future earnings, more than anything else, that will determine Mohawk Industries’ ability to maintain a healthy bottom line going forward. So if you want to see what the pros think, you might find this free report on analyst earnings forecasts interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; you need cold cash. Therefore, clearly we must analyze if that EBIT is generating the corresponding free cash flow. Over the past three years, Mohawk Industries has produced strong free cash flow equal to 77% of its EBIT, which is more or less what we expected. This cold, hard cash means you can reduce your debt whenever you want.
Mohawk Industries’ interest coverage suggests it can manage its debt as easily as Cristiano Ronaldo could score a goal against a 14-year-old’s goalkeeper. But truth be told, we think his level of total responsibility somewhat undermines this impression. Looking at all of the above factors together, we’re surprised Mohawk Industries can manage their debt quite comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is increased risk of loss, so it’s worth monitoring the balance sheet. There is no doubt that we learn more about debt from the balance sheet. However, not all investment risk resides on the balance sheet, far from it. We have identified 1 warning sign with Mohawk Industries, and understanding them should be part of your investment process.
When all is said and done, sometimes it’s easier to focus on businesses that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% freeright now.
Do you have comments about this article? Concerned about the content? Get in touch with us directly. Alternatively, email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock, and it does not take into account your goals or financial situation. Our goal is to provide you with long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
Discounted cash flow calculation for each share
Simply Wall St performs a detailed discounted cash flow calculation every 6 hours for every stock in the market, so if you want to find the intrinsic value of any company, simply search here. It’s free.