Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Electronic Arrow, Inc. (NYSE:ARW) has debt on its balance sheet. But does this debt worry shareholders?
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Arrow Electronics
What is Arrow Electronics’ net debt?
The image below, which you can click on for more details, shows that in April 2022, Arrow Electronics had $3.11 billion in debt, up from $2.27 billion in one year. However, he has $242.8 million in cash to offset this, resulting in a net debt of approximately $2.87 billion.
A Look at Arrow Electronics’ Responsibilities
We can see from the most recent balance sheet that Arrow Electronics had liabilities of US$10.7 billion due in one year, and liabilities of US$3.41 billion due beyond. On the other hand, it had liquidities of 242.8 million dollars and 10.6 billion dollars of receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (current) receivables by $3.22 billion.
This shortfall is not that bad as Arrow Electronics is worth US$7.11 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay debt.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Arrow Electronics has a low net debt to EBITDA ratio of just 1.5. And its EBIT easily covers its interest costs, which is 15.6 times the size. So we’re pretty relaxed about his super conservative use of debt. On top of that, we are pleased to report that Arrow Electronics increased its EBIT by 68%, reducing the specter of future debt repayments. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Arrow Electronics can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cash, not book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Arrow Electronics has had free cash flow of 67% of its EBIT, which is about normal given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
The good news is that Arrow Electronics’ demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. But truth be told, we think his total passive level undermines that impression a bit. Zooming out, Arrow Electronics seems to be using debt quite sensibly; and that gets the green light from us. After all, reasonable leverage can increase return on equity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that Arrow Electronics displays 3 warning signs in our investment analysis and 2 of them make us uncomfortable…
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.