Does Polaris (NYSE:PII) Have A Healthy Balance Sheet?

Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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. Importantly, Polaris Inc. (NYSE:PII) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Polaris

What Is Polaris’s Net Debt?

The chart below, which you can click on for greater detail, shows that Polaris had US$2.06b in debt in March 2024; about the same as the year before. On the flip side, it has US$323.5m in cash leading to net debt of about US$1.74b.

debt-equity-history-analysis
NYSE:PII Debt to Equity History May 22nd 2024

A Look At Polaris’ Liabilities

According to the last reported balance sheet, Polaris had liabilities of US$1.86b due within 12 months, and liabilities of US$2.33b due beyond 12 months. On the other hand, it had cash of US$323.5m and US$265.2m worth of receivables due within a year. So it has liabilities totalling US$3.60b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$4.73b, so it does suggest shareholders should keep an eye on Polaris’ use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Polaris’s net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 4.5 times last year. While these numbers do not alarm us, it’s worth noting that the cost of the company’s debt is having a real impact. Importantly, Polaris’s EBIT fell a jaw-dropping 33% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Polaris 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Polaris’s free cash flow amounted to 26% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.

Our View

We’d go so far as to say Polaris’s EBIT growth rate was disappointing. But at least its net debt to EBITDA is not so bad. Overall, it seems to us that Polaris’s balance sheet is really quite a risk to the business. For this reason we’re pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. We’ve identified 2 warning signs with Polaris , 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.

Valuation is complex, but we’re helping make it simple.

Find out whether Polaris is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

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.

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