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Howard Marks put 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 every investor practice that I know is worried. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We can see that PTL Companies Limited (NSE: PTL) uses debt in its business. But does this debt worry shareholders?
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
See our latest analysis for businesses
What is corporate debt?
You can click on the graph below for historical figures, but it shows that as of September 2021, companies had 519.4 million yen in debt, an increase from 472.0 million yen, on a quarterly basis. year. However, it has € 93.5million in cash offsetting this, leading to net debt of around € 425.9million.
How strong are companies’ balance sheets?
According to the latest published balance sheet, companies had liabilities of 249.8 million yen due within 12 months and liabilities of 2.43 billion yen due beyond 12 months. On the other hand, he had cash of 93.5 million euros and 67.4 million euros in receivables due within one year. It therefore has liabilities totaling 2.51 billion yen more than its combined cash and short-term receivables.
When you consider that this shortfall exceeds the company’s ₹ 2.19b market cap, you might well be inclined to take a close look at the balance sheet. Hypothetically, extremely high dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Corporate net debt is only 0.74 times its EBITDA. And its EBIT easily covers its interest charges, being 112 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. While companies don’t seem to have made much on the EBIT line, at least profits remain stable for now. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in isolation; since businesses will need revenue to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Over the past three years, Enterprises has recorded free cash flow of 55% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
The level of total corporate liabilities and the growth rate of EBIT certainly weighs on this, in our view. But the good news is that he seems to be able to easily cover his interest charges with his EBIT. Looking at all the angles mentioned above, it seems to us that Enterprises is a somewhat risky investment because of its debt. This isn’t necessarily a bad thing, as leverage can increase returns on equity, but it’s something to be aware of. When analyzing debt levels, the balance sheet is the obvious place to start. But at the end of the day, every business can contain risks that exist off the balance sheet. Concrete example: we have spotted 3 warning signs for businesses you must be aware.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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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 any stock 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 any of the stocks mentioned.
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