Here’s why Doman Building Materials Group (TSE:DBM) has significant debt

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 synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Doman Building Materials Group Ltd. (TSE:DBM) is in debt. But the real question is whether this debt makes the business risky.

Why is debt risky?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

Check out our latest analysis for Doman Building Materials Group

How much debt does Doman Building Materials Group have?

As you can see below, Doman Building Materials Group had C$716.2 million in debt as of June 2022, up from C$818.4 million the previous year. And he doesn’t have a lot of cash, so his net debt is about the same.

TSX:DBM Debt to Equity August 6, 2022

How healthy is Doman Building Materials Group’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Doman Building Materials Group had liabilities of C$236.9 million due within 12 months and liabilities of C$865.9 million due beyond. In return, he had C$3.02 million in cash and C$331.4 million in debt due within 12 months. It therefore has liabilities totaling C$768.3 million more than its cash and short-term receivables, combined.

When you consider that this deficit exceeds the company’s C$516.7 million market capitalization, you might well be inclined to take a close look at the balance sheet. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.

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

Doman Building Materials Group has a debt to EBITDA ratio of 4.0 and its EBIT covered its interest expense 3.9 times. This suggests that while debt levels are significant, we will refrain from labeling them problematic. Worse still, Doman Building Materials Group’s EBIT was down 34% from a year ago. If the profits continue like this in the long term, there is an unimaginable chance of repaying this debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Doman Building Materials Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a company can only repay its debts with cold hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Doman Building Materials Group has recorded free cash flow of 81% of its EBIT, which is higher than what we would normally expect. This puts him in a very strong position to pay off the debt.

Our point of view

At first glance, Doman Building Materials Group’s level of total liabilities left us hesitant about the stock, and its EBIT growth rate was no more attractive than the single empty restaurant on the busiest night in the year. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. We are quite clear that we consider Doman Building Materials Group to be quite risky indeed, given the health of its balance sheet. We are therefore almost as suspicious of this stock as a hungry kitten of falling into its owner’s fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 4 warning signs for Doman Building Materials Group (1 is concerning) that you should be aware of.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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