Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that P. H. Glatfelter Company (NYSE:GLT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company’s use of debt, we first look at cash and debt together.
What Is P. H. Glatfelter’s Debt?
As you can see below, P. H. Glatfelter had US$352.0m of debt at September 2019, down from US$646.3m a year prior. However, it also had US$57.0m in cash, and so its net debt is US$295.0m.
A Look At P. H. Glatfelter’s Liabilities
Zooming in on the latest balance sheet data, we can see that P. H. Glatfelter had liabilities of US$217.4m due within 12 months and liabilities of US$489.4m due beyond that. Offsetting these obligations, it had cash of US$57.0m as well as receivables valued at US$121.1m due within 12 months. So its liabilities total US$528.7m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of US$787.1m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
P. H. Glatfelter has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 4.7 times. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. Notably, P. H. Glatfelter’s EBIT launched higher than Elon Musk, gaining a whopping 101% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if P. H. Glatfelter can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it’s worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, P. H. Glatfelter actually produced more free cash flow than EBIT over the last three years. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
The good news is that P. H. Glatfelter’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. All these things considered, it appears that P. H. Glatfelter can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it’s worth monitoring the balance sheet. Of course, we wouldn’t say no to the extra confidence that we’d gain if we knew that P. H. Glatfelter insiders have been buying shares: if you’re on the same wavelength, you can find out if insiders are buying by clicking this link.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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