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Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that The Goodyear Tire & Rubber Company (NASDAQ: GT) uses debt in its business. But does this debt concern shareholders?
What risk does debt entail?
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. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
What is the debt of Goodyear Tire & Rubber?
The image below, which you can click for more details, shows that in June 2021, Goodyear Tire & Rubber was in debt of US $ 7.71 billion, compared to US $ 6.74 billion in one. year. However, it has $ 1.03 billion in cash offsetting that, leading to net debt of around $ 6.68 billion.
NasdaqGS: GT History of debt to equity October 22, 2021
A look at the responsibilities of Goodyear Tire & Rubber
According to the latest published balance sheet, Goodyear Tire & Rubber had liabilities of US $ 6.60 billion due within 12 months and liabilities of US $ 10.2 billion due beyond 12 months. In compensation for these obligations, it had cash of US $ 1.03 billion as well as receivables valued at US $ 2.80 billion within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 12.9 billion.
The lack here weighs heavily on the $ 5.62 billion company itself, as if a child struggles under the weight of a huge backpack full of books, his gym equipment and a trumpet. . We therefore believe that shareholders should watch it closely. After all, Goodyear Tire & Rubber would likely need a major recapitalization if it were to pay its creditors today.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While Goodyear Tire & Rubber’s debt / EBITDA ratio (4.6) suggests that it is using some debt, its interest coverage is very low at 2.5, suggesting high leverage. This is in large part due to the company’s large depreciation and amortization charges, which arguably means that its EBITDA is a very generous measure of profit, and its debt may be heavier than it appears. At first glance. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. A buyout factor for Goodyear Tire & Rubber is that it turned last year’s loss of EBIT into a gain of US $ 677 million over the past twelve months. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Goodyear Tire & Rubber can strengthen its balance sheet over time. So if you want to see what the professionals are thinking, you might find this free report on analysts’ earnings forecasts Be interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Fortunately for all shareholders, Goodyear Tire & Rubber actually generated more free cash flow than EBIT over the past year. There is nothing better than cash flow to stay in the good graces of your lenders.
Our point of view
Reflecting on Goodyear Tire & Rubber’s attempt to stay on top of its total liabilities, we are certainly not enthusiastic. But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Looking at the big picture, it seems clear to us that Goodyear Tire & Rubber’s use of debt creates risks for the business. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you should inquire about the 4 warning signs we spotted with Goodyear Tire & Rubber (including 1 which makes us a little uncomfortable) .
Of course, if you are the type of investor who prefers to buy stocks without going into debt, then feel free to find out. our exclusive list of cash net growth stocks, today.
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 shares 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 the mentioned stocks.
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