Howard Marks said 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 that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies SFL Corporation Ltd. (NYSE:SFL) uses debt. But does this debt worry shareholders?
What risk does debt carry?
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. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth, without any negative consequences. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for SFL
What is SFL’s debt?
As you can see below, at the end of December 2021, SFL had $1.89 billion in debt, up from $1.68 billion a year ago. Click on the image for more details. However, he also had $166.8 million in cash, so his net debt is $1.72 billion.
A look at SFL’s liabilities
According to the last published balance sheet, SFL had liabilities of $400.3 million maturing within 12 months and liabilities of $2.08 billion maturing beyond 12 months. On the other hand, it had liquidities of 166.8 million dollars and 8.56 million dollars of receivables within one year. It therefore has liabilities totaling $2.30 billion more than its cash and short-term receivables, combined.
The deficiency here weighs heavily on the $1.22 billion business itself, like a child struggling under the weight of a huge backpack full of books, his gym gear and a trumpet. . So we definitely think shareholders need to watch this one closely. Ultimately, SFL would likely need a significant recapitalization if its creditors demanded repayment.
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 amortization and depreciation expense.
SFL shareholders are faced with the double whammy of a high net debt to EBITDA ratio (5.0) and a fairly low interest coverage, since EBIT is only 2.4 times the cost of ‘interests. This means that we would consider him to be heavily indebted. The good news is that SFL has improved its EBIT by 3.1% over the last twelve months, thus gradually reducing its level of debt in relation to its results. There is no doubt that we learn the most about debt from the balance sheet. But it is ultimately the company’s future profitability that will decide whether SFL 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, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the last three years, SFL has recorded a free cash flow of 24% of its EBIT, which is lower than expected. It’s not great when it comes to paying off debt.
Our point of view
At first glance, SFL’s net debt to EBITDA ratio left us hesitant about the stock, and its level of total liabilities was no more appealing than the single empty restaurant on the busiest night of the year. But at least its EBIT growth rate isn’t that bad. We are very clear that we consider SFL to be quite risky indeed, given the health of its balance sheet. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, SFL has 5 warning signs (and 2 that make us uncomfortable) that we think you should know about.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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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