Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies LCI Industries (NYSE:LCII) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is LCI Industries's Debt?

As you can see below, LCI Industries had US$829.7m of debt at June 2024, down from US$943.5m a year prior. On the flip side, it has US$130.4m in cash leading to net debt of about US$699.3m.

A Look At LCI Industries' Liabilities

We can see from the most recent balance sheet that LCI Industries had liabilities of US$432.5m falling due within a year, and liabilities of US$1.19b due beyond that. On the other hand, it had cash of US$130.4m and US$333.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.15b.

This deficit isn't so bad because LCI Industries is worth US$2.84b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

LCI Industries has net debt worth 2.1 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.3 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, LCI Industries grew its EBIT by 41% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if LCI Industries can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. During the last three years, LCI Industries generated free cash flow amounting to a very robust 88% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, LCI Industries's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Taking all this data into account, it seems to us that LCI Industries takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for LCI Industries you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.