Is PACCAR (NASDAQ: PCAR) a risky investment?

David Iben put it right when he said: “Volatility is not a risk that is close to our hearts. What matters to us is to avoid the permanent loss of capital. So it seems like smart money knows that debt – which is usually linked to bankruptcies – is a very important factor when you assess the risk of a business. Mostly, PACCAR Inc (NASDAQ: PCAR) is in debt. But the real question is whether this debt makes the business risky.

Why is debt risky?

Generally speaking, debt only becomes a real problem when a business cannot easily repay it, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to issue shares at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.

See our latest analysis for PACCAR

What is the debt of PACCAR?

As you can see below, PACCAR had $ 11.0 billion in debt as of December 2020, which is roughly the same as the year before. You can click on the graph for more details. On the other hand, it has US $ 4.83 billion in cash, which leads to net debt of around US $ 6.14 billion.

NasdaqGS: PCAR debt / equity history March 9, 2021

How healthy is PACCAR’s track record?

The latest balance sheet data shows that PACCAR had commitments of US $ 7.87 billion due within one year and commitments of US $ 10.0 billion thereafter. In contrast, it had US $ 4.83 billion in cash and US $ 1.20 billion in receivables due within one year. Its liabilities therefore exceed the sum of its cash and its (short-term) receivables by US $ 11.8 billion.

While that might sound like a lot, it’s not that bad since PACCAR has a massive market cap of US $ 32.7 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at your ability to repay your debt.

We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) cover his interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt over EBITDA) and the actual interest charges associated with that debt (with its interest coverage ratio).

PACCAR’s net debt is 3.0 times its EBITDA, which represents a significant but still reasonable leverage effect. But her EBIT was around 1k times her interest expense, which means the company isn’t really paying a high cost to maintain that level of debt. Even if the low cost turns out to be unsustainable, that’s a good sign. Importantly, PACCAR’s EBIT has fallen by 47% over the past twelve months. If this earnings trend continues, paying off debt will be about as easy as raising cats on a roller coaster. The balance sheet is clearly the area to focus on when analyzing debt. But it is future profits, more than anything, that will determine PACCAR’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.

But our last consideration is also important, because a business cannot pay its debt with profits on paper; he needs cash. We therefore always check the part of this EBIT which translates into free cash flow. Over the past three years, PACCAR’s free cash flow has stood at 44% of its EBIT, less than we expected. This low cash conversion makes debt management more difficult.

Our point of view

PACCAR’s EBIT growth rate and net debt to EBITDA are definitely weighing on it, in our view. But the good news is that he seems to be able to easily cover his interest costs with his EBIT. When we consider all the factors discussed, it seems to us that PACCAR is taking risks with its use of debt. While this debt can increase returns, we believe the company now has sufficient leverage. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. To this end, you must be aware of the 3 warning signs we spotted with PACCAR .

Of course, if you are the type of investor who prefers to buy stocks without the burden of debt, then feel free to find out. our exclusive list of net cash growth stocks, today.

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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
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