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. So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We can see that Boralex Inc. (TSE:BLX) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Boralex’s Net Debt?
The chart below, which you can click on for greater detail, shows that Boralex had CA$3.38b in debt in June 2019; about the same as the year before. However, because it has a cash reserve of CA$205.0m, its net debt is less, at about CA$3.17b.
How Healthy Is Boralex’s Balance Sheet?
According to the last reported balance sheet, Boralex had liabilities of CA$393.0m due within 12 months, and liabilities of CA$3.57b due beyond 12 months. On the other hand, it had cash of CA$205.0m and CA$113.0m worth of receivables due within a year. So its liabilities total CA$3.64b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the CA$2.01b company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt After all, Boralex would likely require a major re-capitalisation if it had to pay its creditors today.
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.
Boralex shareholders face the double whammy of a high net debt to EBITDA ratio (9.8), and fairly weak interest coverage, since EBIT is just 0.65 times the interest expense. The debt burden here is substantial. Another concern for investors might be that Boralex’s EBIT fell 17% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Boralex 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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, Boralex saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
To be frank both Boralex’s conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its net debt to EBITDA also fails to instill confidence. Considering everything we’ve mentioned above, it’s fair to say that Boralex is carrying heavy debt load. If you play with fire you risk getting burnt, so we’d probably give this stock a wide berth. While Boralex didn’t make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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