Is Bombardier (TSE:BBD.B) Using Too Much Debt?

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Bombardier Inc. (TSE:BBD.B) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Bombardier

What Is Bombardier's Net Debt?

As you can see below, at the end of March 2019, Bombardier had US$9.77b of debt, up from US$9.22b a year ago. Click the image for more detail. However, it also had US$3.52b in cash, and so its net debt is US$6.25b.

How Strong Is Bombardier's Balance Sheet?

According to the last reported balance sheet, Bombardier had liabilities of US$13.3b due within 12 months, and liabilities of US$17.5b due beyond 12 months. Offsetting this, it had US$3.52b in cash and US$4.41b in receivables that were due within 12 months. So its liabilities total US$22.9b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$4.02b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, Bombardier would probably need a major re-capitalization if its creditors were to demand repayment. Either way, since Bombardier does have more debt than cash, it's worth keeping an eye on its balance sheet.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 2.12 times and a disturbingly high net debt to EBITDA ratio of 6.05 hit our confidence in Bombardier like a one-two punch to the gut. The debt burden here is substantial. Looking on the bright side, Bombardier boosted its EBIT by a silky 69% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Bombardier's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Bombardier burned a lot of cash. 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

On the face of it, Bombardier's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. We're quite clear that we consider Bombardier to be really rather risky, as a result of its debt. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on the balance sheet . Over time, share prices tend to follow earnings per share, so if you're interested in Bombardier, you may well want to click here to check an interactive graph of its earnings per share history.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Thank you for reading.