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 note that Corus Entertainment Inc. (TSE:CJR.B) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Corus Entertainment's Debt?
You can click the graphic below for the historical numbers, but it shows that Corus Entertainment had CA$1.48b of debt in November 2020, down from CA$1.69b, one year before. However, because it has a cash reserve of CA$49.9m, its net debt is less, at about CA$1.43b.
A Look At Corus Entertainment's Liabilities
We can see from the most recent balance sheet that Corus Entertainment had liabilities of CA$688.8m falling due within a year, and liabilities of CA$2.23b due beyond that. Offsetting these obligations, it had cash of CA$49.9m as well as receivables valued at CA$393.6m due within 12 months. So its liabilities total CA$2.47b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the CA$1.06b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Corus Entertainment would probably need a major re-capitalization if its creditors were to demand repayment.
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.
Corus Entertainment has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 3.2 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Even worse, Corus Entertainment saw its EBIT tank 28% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that 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 Corus Entertainment 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 always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Corus Entertainment recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
On the face of it, Corus Entertainment's EBIT growth rate 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 on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, it seems to us that Corus Entertainment's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Corus Entertainment (including 1 which makes us a bit uncomfortable) .
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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