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.' 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. We note that DXP Enterprises, Inc. (NASDAQ:DXPE) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is DXP Enterprises's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 DXP Enterprises had US$525.7m of debt, an increase on US$413.1m, over one year. However, it does have US$139.7m in cash offsetting this, leading to net debt of about US$386.0m.

How Strong Is DXP Enterprises' Balance Sheet?

We can see from the most recent balance sheet that DXP Enterprises had liabilities of US$229.4m falling due within a year, and liabilities of US$579.3m due beyond that. Offsetting this, it had US$139.7m in cash and US$349.1m in receivables that were due within 12 months. So its liabilities total US$319.9m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because DXP Enterprises is worth US$756.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While DXP Enterprises has a quite reasonable net debt to EBITDA multiple of 2.4, its interest cover seems weak, at 2.3. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. One way DXP Enterprises could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 19%, as it did over the last year. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if DXP Enterprises can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, DXP Enterprises's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

DXP Enterprises's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to grow its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about DXP Enterprises's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with DXP Enterprises (including 2 which are potentially serious) .

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com