We think Quanex Building Products (NYSE:NX) can manage debt with ease

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Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. 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 Quanex Building Products Corporation (NYSE:NX) has debt on its balance sheet. But the more important question is: what risk does this debt create?

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 common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

How much debt does Quanex Building Products have?

The image below, which you can click on for more details, shows Quanex Building Products had $62.6 million in debt at the end of April 2022, a reduction from $72.3 million year-over-year . On the other hand, he has $38.9 million in cash, resulting in a net debt of around $23.7 million.

NYSE: NX Debt to Equity History August 4, 2022

How healthy is Quanex Building Products’ balance sheet?

The latest balance sheet data shows that Quanex Building Products had liabilities of $146.6 million due within the year, and liabilities of $157.7 million due thereafter. On the other hand, it had liquidities of 38.9 million dollars and 118.2 million dollars of receivables within one year. It therefore has liabilities totaling $147.2 million more than its cash and short-term receivables, combined.

Given that publicly traded Quanex Building Products shares are worth a total of US$800.2 million, it seems unlikely that this level of liability is a major threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.

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 ).

Quanex Building Products’ net debt is only 0.17 times its EBITDA. And its EBIT covers its interest charges 43.6 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Another good sign, Quanex Building Products was able to increase its EBIT by 27% in twelve months, thus facilitating the repayment of its debt. 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 Quanex Building Products can strengthen its balance sheet over time. So if you want to see what the pros think, you might find this free analyst earnings forecast report Be interesting.

Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Quanex Building Products has generated free cash flow of a very strong 87% of EBIT, more than expected. This positions him well to pay off debt if desired.

Our point of view

The good news is that Quanex Building Products’ demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Given this range of factors, it seems to us that Quanex Building Products is quite conservative with its leverage, and the risks appear to be well contained. So we are not worried about using a little leverage on the balance sheet. We’d be very happy to see if Quanex Building Products insiders bought any stock. If you too, then click this link now to take a (free) look at our list of reported insider trading.

If after all this you are more interested in a fast growing company with a strong balance sheet, then check out our list of net cash growth stocks without delay.

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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.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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