Warren Buffett said: “Volatility is far from synonymous with risk. 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. Like many other companies The North West Company Inc. (TSE:NWC) uses debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
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. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for the North West
What is North West’s debt?
As you can see below, North West had C$279.9 million in debt as of October 2021, up from C$339.9 million the previous year. However, he also had C$57.0 million in cash, so his net debt is C$222.9 million.
How strong is North West’s balance sheet?
The latest balance sheet data shows that North West had liabilities of C$322.7 million due within one year, and liabilities of C$348.5 million falling due thereafter. In return, he had C$57.0 million in cash and C$95.5 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables of C$518.7 million.
North West has a market capitalization of C$1.91 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But it is clear that it must be carefully examined whether he can manage his debt without dilution.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without depreciation and amortization charges.
North West’s net debt is only 0.75 times its EBITDA. And its EBIT covers its interest charges 19.1 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Also positive, North West has increased its EBIT by 29% over the past year, which should make it easier to pay down 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 North West 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 company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, North West has recorded free cash flow of 77% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
North West’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And this is only the beginning of good news since its EBIT growth rate is also very encouraging. Given this range of factors, we believe that North West is fairly cautious with its debt, and the risks appear to be well contained. So we are not worried about using a little leverage 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. For example, we found 2 warning signs for the northwest which you should be aware of before investing here.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.
Comments are closed.