Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘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. Importantly, Columbus McKinnon Corporation (NASDAQ:CMCO) does carry debt. But the real question is whether this debt is making the company risky.
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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Columbus McKinnon’s Debt?
As you can see below, Columbus McKinnon had US$308.9m of debt at June 2019, down from US$382.2m a year prior. However, because it has a cash reserve of US$55.7m, its net debt is less, at about US$253.1m.
How Healthy Is Columbus McKinnon’s Balance Sheet?
The latest balance sheet data shows that Columbus McKinnon had liabilities of US$205.0m due within a year, and liabilities of US$433.2m falling due after that. On the other hand, it had cash of US$55.7m and US$135.5m worth of receivables due within a year. So its liabilities total US$447.0m more than the combination of its cash and short-term receivables.
Columbus McKinnon has a market capitalization of US$886.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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.
Columbus McKinnon has net debt worth 2.0 times EBITDA, which isn’t too much, but its interest cover looks a bit on the low side, with EBIT at only 6.3 times the interest expense. While these numbers do not alarm us, it’s worth noting that the cost of the company’s debt is having a real impact. If Columbus McKinnon can keep growing EBIT at last year’s rate of 16% over the last year, then it will find its debt load easier to manage. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Columbus McKinnon 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Columbus McKinnon produced sturdy free cash flow equating to 68% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
Both Columbus McKinnon’s ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. Having said that, its level of total liabilities somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think Columbus McKinnon is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. We’d be motivated to research the stock further if we found out that Columbus McKinnon insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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