Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Cargojet Inc. (TSE:CJT) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Cargojet's Debt?
You can click the graphic below for the historical numbers, but it shows that Cargojet had CA$315.5m of debt in March 2021, down from CA$466.7m, one year before. However, it also had CA$215.8m in cash, and so its net debt is CA$99.7m.
A Look At Cargojet's Liabilities
The latest balance sheet data shows that Cargojet had liabilities of CA$139.4m due within a year, and liabilities of CA$691.3m falling due after that. Offsetting these obligations, it had cash of CA$215.8m as well as receivables valued at CA$44.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$570.1m.
Of course, Cargojet has a market capitalization of CA$3.01b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Looking at its net debt to EBITDA of 0.41 and interest cover of 4.3 times, it seems to us that Cargojet is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably, Cargojet's EBIT launched higher than Elon Musk, gaining a whopping 170% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Cargojet'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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Cargojet recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Cargojet's EBIT growth rate was a real positive on this analysis, as was its net debt to EBITDA. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. Considering this range of data points, we think Cargojet is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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 4 warning signs for Cargojet that you should be aware of before investing here.
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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