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. Importantly, Logistec Corporation (TSE:LGT.B) does carry debt. But the real question is whether this debt is making the company risky.
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Logistec
What Is Logistec's Net Debt?
As you can see below, Logistec had CA$181.9m of debt at September 2020, down from CA$192.0m a year prior. However, it also had CA$23.7m in cash, and so its net debt is CA$158.3m.
How Healthy Is Logistec's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Logistec had liabilities of CA$125.6m due within 12 months and liabilities of CA$392.8m due beyond that. On the other hand, it had cash of CA$23.7m and CA$179.7m worth of receivables due within a year. So it has liabilities totalling CA$315.0m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of CA$484.3m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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).
Logistec has net debt worth 2.2 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.9 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Logistec grew its EBIT by 89% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Logistec's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Logistec actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Our View
Happily, Logistec's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its interest cover. It's also worth noting that Logistec is in the Infrastructure industry, which is often considered to be quite defensive. Taking all this data into account, it seems to us that Logistec takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Logistec .
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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About TSX:LGT.B
Logistec
Logistec Corporation, together with its subsidiaries, provides cargo handling and other services to marine, industrial, and municipal customers in Canada and the United States.
Slightly overvalued with imperfect balance sheet.
