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. We can see that Linamar Corporation (TSE:LNR) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Linamar's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Linamar had CA$710.7m of debt in March 2022, down from CA$915.5m, one year before. But it also has CA$903.9m in cash to offset that, meaning it has CA$193.3m net cash.
A Look At Linamar's Liabilities
Zooming in on the latest balance sheet data, we can see that Linamar had liabilities of CA$2.09b due within 12 months and liabilities of CA$846.5m due beyond that. On the other hand, it had cash of CA$903.9m and CA$1.06b worth of receivables due within a year. So its liabilities total CA$965.0m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Linamar has a market capitalization of CA$3.34b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Linamar also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the bad news is that Linamar has seen its EBIT plunge 16% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Linamar's ability to maintain a healthy balance sheet going forward. 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. While Linamar has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Linamar actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Although Linamar's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CA$193.3m. The cherry on top was that in converted 148% of that EBIT to free cash flow, bringing in CA$466m. So we are not troubled with Linamar's debt use. 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. Be aware that Linamar is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...
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. 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.