David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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 FRP Holdings, Inc. (NASDAQ:FRPH) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does FRP Holdings Carry?
The chart below, which you can click on for greater detail, shows that FRP Holdings had US$88.9m in debt in December 2019; about the same as the year before. However, it does have US$26.6m in cash offsetting this, leading to net debt of about US$62.3m.
How Healthy Is FRP Holdings’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that FRP Holdings had liabilities of US$2.94m due within 12 months and liabilities of US$143.6m due beyond that. Offsetting this, it had US$26.6m in cash and US$546.0k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$119.4m.
This deficit isn’t so bad because FRP Holdings is worth US$376.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
As it happens FRP Holdings has a fairly concerning net debt to EBITDA ratio of 6.3 but very strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Pleasingly, FRP Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 103% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can’t view debt in total isolation; since FRP Holdings will need earnings to service that debt. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, FRP Holdings actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Happily, FRP Holdings’s impressive interest cover implies it has the upper hand on its debt. But we must concede we find its net debt to EBITDA has the opposite effect. Taking all this data into account, it seems to us that FRP Holdings takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. Take risks, for example – FRP Holdings has 1 warning sign we think you should be aware of.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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