We Think GFL Environmental (TSE:GFL) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 GFL Environmental Inc. (TSE:GFL) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for GFL Environmental

What Is GFL Environmental's Net Debt?

As you can see below, at the end of June 2024, GFL Environmental had CA$9.68b of debt, up from CA$7.90b a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

How Strong Is GFL Environmental's Balance Sheet?

The latest balance sheet data shows that GFL Environmental had liabilities of CA$1.81b due within a year, and liabilities of CA$11.5b falling due after that. Offsetting this, it had CA$134.2m in cash and CA$1.19b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$12.0b.

GFL Environmental has a very large market capitalization of CA$22.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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.

Weak interest cover of 0.68 times and a disturbingly high net debt to EBITDA ratio of 5.4 hit our confidence in GFL Environmental like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. The good news is that GFL Environmental grew its EBIT a smooth 30% over the last twelve months. 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if GFL Environmental 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, GFL Environmental produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

GFL Environmental's interest cover was a real negative on this analysis, as was its net debt to EBITDA. But like a ballerina ending on a perfect pirouette, it has not trouble growing its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about GFL Environmental's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 2 warning signs for GFL Environmental that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.