Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Fastenal Company (NASDAQ:FAST) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Fastenal's Net Debt?
As you can see below, at the end of June 2022, Fastenal had US$505.0m of debt, up from US$405.0m a year ago. Click the image for more detail. However, it does have US$247.9m in cash offsetting this, leading to net debt of about US$257.1m.
How Healthy Is Fastenal's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Fastenal had liabilities of US$849.0m due within 12 months and liabilities of US$564.6m due beyond that. On the other hand, it had cash of US$247.9m and US$1.10b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$61.8m.
This state of affairs indicates that Fastenal'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$27.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Fastenal has virtually no net debt, so it's fair to say it does not have a heavy debt load!
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Fastenal has a low net debt to EBITDA ratio of only 0.17. And its EBIT covers its interest expense a whopping 143 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Fastenal grew its EBIT by 18% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Fastenal can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Fastenal recorded free cash flow worth 62% 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 Fastenal's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Looking at the bigger picture, we think Fastenal's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Fastenal that you should be aware of before investing here.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
