Here’s why Safe Bulkers (NYSE:SB) can manage debt responsibly
Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Safe Bulkers, Inc. (NYSE: SB) uses debt in its operations. But should shareholders worry about its use of debt?
When is debt a problem?
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. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we look at debt levels, we first consider cash and debt levels, together.
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How much debt does Safe Bulkers have?
You can click on the chart below for historical numbers, but it shows Safe Bulkers had $424.8 million in debt in June 2022, up from $474.6 million a year prior. However, he has $129.1 million in cash to offset this, resulting in a net debt of approximately $295.6 million.
How strong is Safe Bulkers’ balance sheet?
The latest balance sheet data shows that Safe Bulkers had liabilities of $76.2 million due within the year, and liabilities of $414.3 million due thereafter. In return, it had $129.1 million in cash and $8.75 million in receivables due within 12 months. It therefore has liabilities totaling $352.7 million more than its cash and short-term receivables, combined.
When you consider that shortfall exceeds the company’s US$339.1 million market capitalization, you might well be inclined to take a close look at the balance sheet. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.
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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Safe Bulkers’ net debt is only 1.2 times its EBITDA. And its EBIT covers its interest charges 22.4 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Even better, Safe Bulkers increased its EBIT by 120% last year, which is an impressive improvement. If sustained, this growth will make debt even more manageable in years to come. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Safe Bulkers can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
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 three years, Safe Bulkers has recorded free cash flow of 71% 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, Safe Bulkers’ impressive interest coverage means it has the upper hand on its debt. But the hard truth is that we are concerned about his total passive level. Looking at all of the aforementioned factors together, it seems to us that Safe Bulkers can manage their debt quite comfortably. On the plus side, this leverage can increase shareholder returns, but the potential downside is more risk of loss, so it’s worth keeping an eye on the balance sheet. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. To do this, you need to find out about the 3 warning signs we spotted some with Safe Bulkers (including 1 that is significant).
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.
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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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