Is Tricon Residential (TSE:TCN) A Risky Investment?

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.' 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 note that Tricon Residential Inc. (TSE:TCN) does have debt on its balance sheet. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Tricon Residential

What Is Tricon Residential's Net Debt?

As you can see below, at the end of March 2023, Tricon Residential had US$5.97b of debt, up from US$4.65b a year ago. Click the image for more detail. However, it does have US$142.4m in cash offsetting this, leading to net debt of about US$5.83b.

How Strong Is Tricon Residential's Balance Sheet?

The latest balance sheet data shows that Tricon Residential had liabilities of US$1.19b due within a year, and liabilities of US$7.55b falling due after that. Offsetting these obligations, it had cash of US$142.4m as well as receivables valued at US$22.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$8.58b.

This deficit casts a shadow over the US$2.26b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Tricon Residential 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). 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).

Tricon Residential shareholders face the double whammy of a high net debt to EBITDA ratio (12.0), and fairly weak interest coverage, since EBIT is just 1.9 times the interest expense. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Tricon Residential actually grew its EBIT by a hefty 132%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tricon Residential 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Tricon Residential's free cash flow amounted to 48% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On the face of it, Tricon Residential's net debt to EBITDA 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 EBIT growth rate is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Tricon Residential's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Tricon Residential (including 2 which are a bit unpleasant) .

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.