These 4 metrics indicate that Douglas Dynamics (NYSE:PLOW) is using debt heavily

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David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Douglas Dynamics, Inc. (NYSE:PLOW) has debt on its balance sheet. But the real question is whether this debt makes the business risky.

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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for Douglas Dynamics

How much debt does Douglas Dynamics have?

As you can see below, Douglas Dynamics had $229.2 million in debt as of March 2022, up from $240.9 million the previous year. However, since he has a cash reserve of $8.21 million, his net debt is less, at around $221.0 million.

NYSE: PLOW Debt to Equity History as of July 30, 2022

How strong is Douglas Dynamics’ balance sheet?

Zooming in on the latest balance sheet data, we can see that Douglas Dynamics had liabilities of US$73.6 million due within 12 months and liabilities of US$269.8 million due beyond. In return, he had $8.21 million in cash and $44.5 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $290.6 million.

While that might sound like a lot, it’s not that bad since Douglas Dynamics has a market capitalization of US$729.2 million, so it could probably bolster its balance sheet by raising capital if needed. However, it is always worth taking a close look at its 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). The advantage of this approach is that we consider 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 ).

Douglas Dynamics has a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 4.2 times. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. Worse still, Douglas Dynamics’ EBIT was down 28% from a year ago. If earnings continue to follow this trajectory, paying off this debt will be more difficult than convincing us to run a marathon in the rain. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Douglas Dynamics can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Douglas Dynamics has produced strong free cash flow equivalent to 74% of its EBIT, which is what we expected. This cold hard cash allows him to reduce his debt whenever he wants.

Our point of view

Douglas Dynamics’ struggle to increase EBIT made us doubt the strength of its balance sheet, but the other data points we considered were relatively rewarding. For example, its conversion of EBIT to free cash flow was refreshing. Considering the above factors, we believe that Douglas Dynamics’ debt poses certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 2 warning signs with Douglas Dynamics, and understanding them should be part of your investment process.

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.

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.

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