FreightCar America (NASDAQ:RAIL) Seems To Be Using A Lot Of Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 FreightCar America, Inc. (NASDAQ:RAIL) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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.

See our latest analysis for FreightCar America

What Is FreightCar America's Debt?

As you can see below, FreightCar America had US$31.1m of debt at September 2023, down from US$91.6m a year prior. However, it also had US$10.3m in cash, and so its net debt is US$20.8m.

How Healthy Is FreightCar America's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that FreightCar America had liabilities of US$85.5m due within 12 months and liabilities of US$104.8m due beyond that. Offsetting these obligations, it had cash of US$10.3m as well as receivables valued at US$13.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$166.6m.

This deficit casts a shadow over the US$45.7m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, FreightCar America would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While FreightCar America has a quite reasonable net debt to EBITDA multiple of 1.7, its interest cover seems weak, at 0.38. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. We also note that FreightCar America improved its EBIT from a last year's loss to a positive US$7.9m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if FreightCar America can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, FreightCar America 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.

Our View

To be frank both FreightCar America'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. Having said that, its ability handle its debt, based on its EBITDA, isn't such a worry. Taking into account all the aforementioned factors, it looks like FreightCar America has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with FreightCar America (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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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.