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Shareholders of Distribution Solutions would probably like to forget the past six months even happened. The stock dropped 34.1% and now trades at $26.44. This might have investors contemplating their next move.
Is there a buying opportunity in Distribution Solutions, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Even with the cheaper entry price, we don't have much confidence in Distribution Solutions. Here are three reasons why there are better opportunities than DSGR and a stock we'd rather own.
Why Is Distribution Solutions Not Exciting?
Founded in 1952, Distribution Solutions (NASDAQ:DSGR) provides supply chain solutions and distributes industrial, safety, and maintenance products to various industries.
1. Weak Operating Margin Could Cause Trouble
Operating margin is a key measure of profitability. Think of it as net income - the bottom line - excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.
Distribution Solutions was profitable over the last four years but held back by its large cost base. Its average operating margin of 5.3% was weak for an industrials business. This result is surprising given its high gross margin as a starting point.
2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
Distribution Solutions has shown poor cash profitability over the last four years, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 1.2%, lousy for an industrials business.
3. High Debt Levels Increase Risk
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Distribution Solutions’s $831.1 million of debt exceeds the $66.48 million of cash on its balance sheet. Furthermore, its 6× net-debt-to-EBITDA ratio (based on its EBITDA of $136.6 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Distribution Solutions could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.