Health Check: How Prudently Does TORM (CPH:TRMD A) Use Debt?

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 TORM plc (CPH:TRMD A) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for TORM

How Much Debt Does TORM Carry?

The image below, which you can click on for greater detail, shows that at September 2021 TORM had debt of US$964.8m, up from US$786.7m in one year. However, it also had US$104.2m in cash, and so its net debt is US$860.6m.

How Strong Is TORM's Balance Sheet?

According to the last reported balance sheet, TORM had liabilities of US$277.3m due within 12 months, and liabilities of US$908.0m due beyond 12 months. Offsetting these obligations, it had cash of US$104.2m as well as receivables valued at US$105.6m due within 12 months. So its liabilities total US$975.5m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$644.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, TORM would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine TORM'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.

Over 12 months, TORM made a loss at the EBIT level, and saw its revenue drop to US$547m, which is a fall of 34%. That makes us nervous, to say the least.

Caveat Emptor

While TORM's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost US$24m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$255m in negative free cash flow over the last year. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example TORM has 2 warning signs (and 1 which is significant) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.