Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We can see that Lennar Corporation (NYSE: LEN) uses debt in its business. But the most important question is: what risk does this debt create?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest review for Lennar
How much debt does Lennar have?
You can click on the graph below for the historical numbers, but it shows that Lennar was in debt of US $ 4.65 billion in November 2021, down from US $ 7.42 billion a year earlier. However, he also had $ 2.74 billion in cash, so his net debt is $ 1.92 billion.
A look at Lennar’s responsibilities
The latest balance sheet data shows Lennar had $ 1.32 billion in liabilities due within one year, and $ 10.9 billion in liabilities due after that. On the other hand, he had $ 2.74 billion in cash and $ 490.3 million in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 8.99 billion.
While that might sound like a lot, it’s not that big of a deal since Lennar has a massive market cap of US $ 31.2 billion, so she could likely strengthen her 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 ) covers its interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt compared to EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Lennar has a low net debt to EBITDA ratio of just 0.32. And its EBIT covers its interest costs 290 times. So we’re pretty relaxed about its ultra-conservative use of debt. On top of that, we are happy to report that Lennar has increased its EBIT by 89%, reducing the specter of future debt repayments. There is no doubt that we learn the most about debt from the balance sheet. But it’s future earnings, more than anything, that will determine Lennar’s ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Lennar has generated strong free cash flow equivalent to 71% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Fortunately, Lennar’s impressive interest coverage means he has the upper hand on his debt. And that’s just the start of good news as its EBIT growth rate is also very encouraging. Looking at the big picture, we think Lennar’s use of debt looks very reasonable and we don’t care. After all, reasonable leverage can increase returns on equity. We would be very happy to see if Lennar insiders have recovered any shares. If you are too, click this link now to take a (free) look at our list of reported insider trades.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is 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 documents. Simply Wall St has no position in any of the stocks mentioned.