Tornado Global Hydrovacs (CVE:TGH) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Tornado Global Hydrovacs Ltd. (CVE:TGH) does use debt in its business. But is this debt a concern to shareholders?

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. 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, 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.

View our latest analysis for Tornado Global Hydrovacs

What Is Tornado Global Hydrovacs's Net Debt?

As you can see below, at the end of June 2023, Tornado Global Hydrovacs had CA$10.3m of debt, up from CA$7.30m a year ago. Click the image for more detail. However, it does have CA$1.44m in cash offsetting this, leading to net debt of about CA$8.83m.

How Strong Is Tornado Global Hydrovacs' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tornado Global Hydrovacs had liabilities of CA$23.2m due within 12 months and liabilities of CA$4.53m due beyond that. Offsetting these obligations, it had cash of CA$1.44m as well as receivables valued at CA$7.96m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$18.3m.

While this might seem like a lot, it is not so bad since Tornado Global Hydrovacs has a market capitalization of CA$67.3m, 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tornado Global Hydrovacs has net debt worth 1.6 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.9 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. It was also good to see that despite losing money on the EBIT line last year, Tornado Global Hydrovacs turned things around in the last 12 months, delivering and EBIT of CA$4.2m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Tornado Global Hydrovacs 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Tornado Global Hydrovacs 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

Tornado Global Hydrovacs'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. But on the bright side, its ability to handle its debt, based on its EBITDA, isn't too shabby at all. When we consider all the factors discussed, it seems to us that Tornado Global Hydrovacs is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Tornado Global Hydrovacs (2 are a bit concerning!) that you should be aware of before investing here.

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.

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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.