We Think Flight Centre Travel Group (ASX:FLT) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Flight Centre Travel Group Limited (ASX:FLT) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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.

Check out our latest analysis for Flight Centre Travel Group

What Is Flight Centre Travel Group's Debt?

As you can see below, at the end of June 2023, Flight Centre Travel Group had AU$1.13b of debt, up from AU$1.06b a year ago. Click the image for more detail. On the flip side, it has AU$946.6m in cash leading to net debt of about AU$188.0m.

How Healthy Is Flight Centre Travel Group's Balance Sheet?

We can see from the most recent balance sheet that Flight Centre Travel Group had liabilities of AU$1.97b falling due within a year, and liabilities of AU$1.33b due beyond that. Offsetting this, it had AU$946.6m in cash and AU$1.18b in receivables that were due within 12 months. So it has liabilities totalling AU$1.18b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Flight Centre Travel Group has a market capitalization of AU$4.63b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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.

Given net debt is only 1.1 times EBITDA, it is initially surprising to see that Flight Centre Travel Group's EBIT has low interest coverage of 2.5 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, Flight Centre Travel Group made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$131m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Flight Centre Travel Group 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 it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Looking at the most recent year, Flight Centre Travel Group recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Flight Centre Travel Group's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that it has an adequate capacity handle its debt, based on its EBITDA,. Looking at all this data makes us feel a little cautious about Flight Centre Travel Group's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Flight Centre Travel Group , and understanding them should be part of your investment process.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.