Armstrong World Industries (NYSE:AWI) seems to be using debt quite wisely

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”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Armstrong World Industries, Inc. (NYSE:AWI) uses debt. But should shareholders worry about its use of debt?

What risk does debt carry?

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 painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.

See our latest analysis for Armstrong World Industries

How much debt does Armstrong World Industries have?

The image below, which you can click on for more details, shows that Armstrong World Industries had $644.2 million in debt at the end of March 2022, a reduction from $733.6 million on a year. On the other hand, he has $76.1 million in cash, resulting in a net debt of around $568.1 million.

NYSE: AWI Debt to Equity History April 28, 2022

How strong is Armstrong World Industries’ balance sheet?

Zooming in on the latest balance sheet data, we can see that Armstrong World Industries had liabilities of US$192.8 million due within 12 months and liabilities of US$977.7 million due beyond. On the other hand, it had liquidities of 76.1 million dollars and 114.5 million dollars of receivables within one year. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $979.9 million.

While that might sound like a lot, it’s not too bad since Armstrong World Industries has a market capitalization of US$4.07 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

With a debt to EBITDA ratio of 2.0, Armstrong World Industries uses debt wisely but responsibly. And the attractive interest coverage (EBIT of 8.9 times interest expense) certainly makes do not do everything to dispel this impression. It should also be noted that Armstrong World Industries has increased its EBIT by a very respectable 20% over the past year, improving its ability to repay debt. The balance sheet is clearly the area to focus on when analyzing debt. But future earnings, more than anything, will determine Armstrong World Industries’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Armstrong World Industries has produced strong free cash flow of 62% of EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

Armstrong World Industries’ EBIT growth rate suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And that’s just the start of the good news as his interest coverage is also very pleasing. When we consider the range of factors above, it appears that Armstrong World Industries is quite sensitive with its use of debt. While this carries some risk, it can also improve shareholder returns. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 1 warning sign for Armstrong World Industries of which you should be aware.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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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