We Think Tassal Group (ASX:TGR) Is Taking Some Risk With Its Debt

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. As with many other companies Tassal Group Limited (ASX:TGR) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Tassal Group

What Is Tassal Group's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2020 Tassal Group had debt of AU$219.6m, up from AU$176.9m in one year. However, it does have AU$21.9m in cash offsetting this, leading to net debt of about AU$197.8m.

How Strong Is Tassal Group's Balance Sheet?

We can see from the most recent balance sheet that Tassal Group had liabilities of AU$180.3m falling due within a year, and liabilities of AU$545.4m due beyond that. On the other hand, it had cash of AU$21.9m and AU$55.9m worth of receivables due within a year. So it has liabilities totalling AU$648.0m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of AU$773.5m, so it does suggest shareholders should keep an eye on Tassal Group's use of debt. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tassal Group has a low net debt to EBITDA ratio of only 1.4. And its EBIT covers its interest expense a whopping 10.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that Tassal Group grew its EBIT by 17% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tassal 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Tassal Group saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Tassal Group's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its interest cover was refreshing. When we consider all the factors discussed, it seems to us that Tassal Group is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Tassal Group that you should be aware of.

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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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. 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.
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