Warren Buffett said: “Volatility is far from synonymous with risk”. 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 notice that Tervita Company (TSE: TEV) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
When is debt a problem?
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. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider both cash and debt levels.
Check out our latest analysis for Tervita
What is Tervita’s debt?
The image below, which you can click for more details, shows Tervita owed C $ 711.0 million at the end of March 2021, a reduction from C $ 838.0 million. over a year. However, it has C $ 21.0 million in cash offsetting this, leading to net debt of approximately C $ 690.0 million.
A look at Tervita’s responsibilities
Zooming in on the latest balance sheet data, we can see that Tervita had a liability of C $ 184.0 million due within 12 months and a liability of C $ 1.10 billion beyond. On the other hand, it had C $ 21.0 million in cash and C $ 137.0 million in receivables due within one year. Its liabilities therefore total C $ 1.12 billion more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the C $ 608.4 million society, like a towering colossus of mere mortals. So we would be watching its record closely, without a doubt. Ultimately, Tervita would likely need a major recapitalization if her creditors demanded repayment.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While Tervita’s debt-to-EBITDA ratio (4.0) suggests that it is using some debt, its interest coverage is very low, at 0.84, suggesting high leverage. This is in large part due to the company’s large depreciation and amortization charges, which arguably means that its EBITDA is a very generous measure of profit, and its debt may be heavier than it appears. At first glance. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Worse, Tervita’s EBIT fell 32% compared to last year. If the income continues like this for the long haul, there is an incredible chance to pay off that debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Tervita 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 needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Tervita has recorded free cash flow of 32% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.
Our point of view
To be frank, Tervita’s EBIT growth rate and track record of controlling its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its net debt to EBITDA also fails to inspire confidence. Considering all of the aforementioned factors, it seems Tervita has too much debt. While some investors like this kind of risky game, it is certainly not our cup of tea. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Tervita (of which 1 is significant!) that you should know.
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-flow net-growth stocks.
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