Here’s Why Uni-Select (TSE:UNS) Is Weighed Down By Its Debt Load

Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We note that Uni-Select Inc. (TSE:UNS) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Uni-Select

What Is Uni-Select’s Debt?

As you can see below, at the end of June 2020, Uni-Select had US$463.6m of debt, up from US$423.9m a year ago. Click the image for more detail. However, it does have US$40.9m in cash offsetting this, leading to net debt of about US$422.7m.

debt-equity-history-analysis
TSX:UNS Debt to Equity History September 4th 2020

How Strong Is Uni-Select’s Balance Sheet?

According to the last reported balance sheet, Uni-Select had liabilities of US$306.5m due within 12 months, and liabilities of US$592.2m due beyond 12 months. On the other hand, it had cash of US$40.9m and US$205.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$652.6m.

This deficit casts a shadow over the US$225.2m company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt. At the end of the day, Uni-Select would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.93 times and a disturbingly high net debt to EBITDA ratio of 6.7 hit our confidence in Uni-Select like a one-two punch to the gut. This means we’d consider it to have a heavy debt load. Even worse, Uni-Select saw its EBIT tank 54% over the last 12 months. If earnings keep going like that over the long term, it has a snowball’s chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Uni-Select can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Uni-Select generated free cash flow amounting to a very robust 99% of its EBIT, more than we’d expect. That positions it well to pay down debt if desirable to do so.

Our View

On the face of it, Uni-Select’s EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think Uni-Select has too much debt. That sort of riskiness is ok for some, but it certainly doesn’t float our boat. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. Consider for instance, the ever-present spectre of investment risk. We’ve identified 2 warning signs with Uni-Select (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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