Is Uni-Select (TSE:UNS) A Risky Investment?

By
Simply Wall St
Published
March 16, 2022
TSX:UNS
Source: Shutterstock

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. As with many other companies Uni-Select Inc. (TSE:UNS) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Uni-Select

What Is Uni-Select's Debt?

As you can see below, Uni-Select had US$313.1m of debt at December 2021, down from US$404.4m a year prior. On the flip side, it has US$41.9m in cash leading to net debt of about US$271.2m.

debt-equity-history-analysis
TSX:UNS Debt to Equity History March 16th 2022

How Healthy Is Uni-Select's Balance Sheet?

We can see from the most recent balance sheet that Uni-Select had liabilities of US$363.2m falling due within a year, and liabilities of US$441.6m due beyond that. Offsetting this, it had US$41.9m in cash and US$186.3m in receivables that were due within 12 months. So its liabilities total US$576.7m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Uni-Select has a market capitalization of US$969.8m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). 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).

While we wouldn't worry about Uni-Select's net debt to EBITDA ratio of 3.4, we think its super-low interest cover of 1.9 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The silver lining is that Uni-Select grew its EBIT by 166% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Uni-Select's ability to maintain a healthy balance sheet going forward. 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 we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Uni-Select actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Both Uni-Select's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to cover its interest expense with its EBIT. Considering this range of data points, we think Uni-Select is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. We've identified 3 warning signs with Uni-Select (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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