Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, Covenant Logistics Group, Inc. (NASDAQ:CVLG) is in debt. But the more important question is: what risk does this debt create?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.
How much debt does Covenant Logistics Group have?
As you can see below, at the end of June 2022, Covenant Logistics Group had $58.5 million in debt, up from $45.7 million a year ago. Click on the image for more details. However, since he has a cash reserve of $4.46 million, his net debt is less, at around $54.0 million.
A look at the responsibilities of Covenant Logistics Group
We can see from the most recent balance sheet that Covenant Logistics Group had liabilities of US$150.4 million due in one year, and liabilities of US$194.5 million due beyond. As compensation for these obligations, it had cash of US$4.46 million and receivables valued at US$141.2 million due within 12 months. It therefore has liabilities totaling $199.3 million more than its cash and short-term receivables, combined.
Covenant Logistics Group has a market capitalization of US$403.7 million, so it could very likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.
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.
Covenant Logistics Group has a low net debt to EBITDA ratio of just 0.38. And its EBIT covers its interest charges 32.9 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. What is even more impressive is that Covenant Logistics Group increased its EBIT by 120% year-over-year. If sustained, this growth will make debt even more manageable in years to come. When analyzing debt levels, the balance sheet is the obvious starting point. But future earnings, more than anything, will determine Covenant Logistics Group’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecasts.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past two years, Covenant Logistics Group has recorded free cash flow of 62% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Fortunately, Covenant Logistics Group’s impressive interest coverage means it has the upper hand on its debt. But truth be told, we think his total passive level undermines that impression a bit. Zooming out, Covenant Logistics Group appears to be using debt quite sensibly; and that gets the green light from us. After all, reasonable leverage can increase return on equity. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To do this, you need to find out about the 2 warning signs we spotted with Covenant Logistics Group (including 1 that made us a little uneasy) .
If you are interested in investing in companies that can generate profits without the burden of debt, then 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 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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