David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Curaleaf Holdings, Inc. (CSE:CURA) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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.
How Much Debt Does Curaleaf Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Curaleaf Holdings had US$280.0m of debt, an increase on US$106.0m, over one year. However, it does have US$84.6m in cash offsetting this, leading to net debt of about US$195.4m.
How Healthy Is Curaleaf Holdings' Balance Sheet?
According to the last reported balance sheet, Curaleaf Holdings had liabilities of US$177.2m due within 12 months, and liabilities of US$796.4m due beyond 12 months. Offsetting these obligations, it had cash of US$84.6m as well as receivables valued at US$23.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$866.0m.
Given Curaleaf Holdings has a market capitalization of US$9.08b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Even though Curaleaf Holdings's debt is only 1.5, its interest cover is really very low at 1.8. This does have us wondering if the company pays high interest because it is considered risky. Either way there's no doubt the stock is using meaningful leverage. We also note that Curaleaf Holdings improved its EBIT from a last year's loss to a positive US$77m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Curaleaf Holdings 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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, Curaleaf Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While Curaleaf Holdings's interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. But its not so bad at managing its debt, based on its EBITDA,. When we consider all the factors discussed, it seems to us that Curaleaf Holdings is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. Be aware that Curaleaf Holdings is showing 4 warning signs in our investment analysis , you should know about...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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