David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, THOR Industries, Inc. (NYSE:THO) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does THOR Industries Carry?

The image below, which you can click on for greater detail, shows that THOR Industries had debt of US$1.24b at the end of April 2024, a reduction from US$1.65b over a year. However, because it has a cash reserve of US$371.8m, its net debt is less, at about US$872.7m.

A Look At THOR Industries' Liabilities

Zooming in on the latest balance sheet data, we can see that THOR Industries had liabilities of US$1.74b due within 12 months and liabilities of US$1.47b due beyond that. Offsetting this, it had US$371.8m in cash and US$830.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.01b.

This deficit isn't so bad because THOR Industries is worth US$5.38b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While THOR Industries's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.7 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, THOR Industries's EBIT fell a jaw-dropping 45% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine THOR Industries's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, THOR Industries recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

THOR Industries's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its conversion of EBIT to free cash flow was re-invigorating. Looking at all the angles mentioned above, it does seem to us that THOR Industries is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with THOR Industries , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.