David Iben put it well when he said, âVolatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that TPI Composites, Inc. (NASDAQ: TPIC) uses debt in its business. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution of a business with the ability to reinvest at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest review for TPI composites
How many debts does TPI Composites carry?
The image below, which you can click for more details, shows that as of September 2021, TPI Composites was in debt of $ 255.5 million, up from $ 228.8 million in one year. However, given that it has a cash reserve of US $ 119.0 million, its net debt is less, at approximately US $ 136.5 million.
How strong is TPI Composites’ balance sheet?
According to the latest published balance sheet, TPI Composites had liabilities of US $ 663.3 million due within 12 months and liabilities of US $ 168.3 million due beyond 12 months. In compensation for these obligations, it had cash of US $ 119.0 million as well as receivables valued at US $ 422.9 million due within 12 months. Its liabilities therefore total US $ 289.6 million more than the combination of its cash and short-term receivables.
TPI Composites has a market capitalization of US $ 810.4 million, so it could most likely raise funds to improve its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While TPI Composites has a very reasonable net debt to EBITDA ratio of 2.3, its interest coverage appears low at 0.82. The main reason is that it has such high depreciation and amortization. While companies often boast that these fees are not cash, most of these companies will therefore need an ongoing investment (which is not expensed). In any case, we can say that the company has a significant debt. Shareholders should know that TPI Composites’ EBIT fell 64% last year. If this profit trend continues, paying off debt will be about as easy as driving cats on a roller coaster. The balance sheet is clearly the area to focus on when analyzing debt. But it is future profits, more than anything, that will determine TPI Composites’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Over the past three years, TPI Composites has spent a lot of money. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
To be frank, TPI Composites’ EBIT conversion to free cash flow and its track record of (not) growing its EBIT makes us rather uncomfortable with its leverage levels. That said, his ability to manage his total liabilities isn’t that much of a concern. Overall, it seems to us that TPI Composites’ balance sheet is really very risky for the company. For this reason, we are quite cautious on the stock, and we believe that shareholders should keep a close eye on its liquidity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 2 warning signs for TPI composites which you should know before investing here.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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 documents. Simply Wall St has no position in any of the stocks mentioned.
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