Is Cleanaway Waste Management (ASX: CWY) a risky investment?
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”. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We note that Cleanaway Waste Management Limited (ASX: CWY) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we look at debt levels, we first consider both liquidity and debt levels.
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What is the debt of Cleanaway Waste Management?
As you can see below, Cleanaway Waste Management was in debt of A $ 605.4 million in June 2021, which is roughly the same as the year before. You can click on the graph for more details. However, it has A $ 69.4 million in cash offsetting this, leading to net debt of around A $ 536.0 million.
A look at the responsibilities of Cleanaway Waste Management
According to the latest published balance sheet, Cleanaway Waste Management had a liability of AU $ 564.0 million due within 12 months and a liability of AU $ 1.45 billion due beyond 12 months. In compensation for these obligations, it had cash of A $ 69.4 million as well as receivables valued at A $ 376.1 million maturing within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by AU $ 1.57 billion.
While that might sound like a lot, it’s not that big of a deal since Cleanaway Waste Management has a market cap of AU $ 5.53 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). 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).
While Cleanaway Waste Management’s low debt-to-EBITDA ratio of 1.2 suggests modest use of debt, the fact that EBIT only covered interest expense 2.7 times last year gives us pause. But the interest payments are certainly enough to make us think about how affordable his debt is. We note that Cleanaway Waste Management has increased its EBIT by 29% over the past year, which should make it easier to repay debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Cleanaway Waste Management 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.
Finally, a business can only pay off its debts with hard cash, not with book profits. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Cleanaway Waste Management has generated free cash flow of a very solid 81% of its EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
The conversion of Cleanaway Waste Management’s EBIT to free cash flow suggests that it can manage its debt as easily as Cristiano Ronaldo could score a goal against an under-14 goalkeeper. But we have to admit that we find that its hedging interest has the opposite effect. When we consider the above range of factors, it seems that Cleanaway Waste Management is quite reasonable with its use of debt. This means that they are taking a bit more risk, in the hope of increasing returns for shareholders. We would be motivated to seek more stock if we found out that Cleanaway Waste Management insiders have recently bought stocks. If you too are in luck, because today we are sharing our list of reported insider trades for free.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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 material. Simply Wall St has no position in any of the stocks mentioned.
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