Here's Why Titan Machinery (NASDAQ:TITN) Has A Meaningful Debt Burden

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.' 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, Titan Machinery Inc. (NASDAQ:TITN) does carry debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for Titan Machinery

What Is Titan Machinery's Debt?

As you can see below, at the end of January 2024, Titan Machinery had US$1.00b of debt, up from US$344.3m a year ago. Click the image for more detail. On the flip side, it has US$38.1m in cash leading to net debt of about US$965.9m.

How Healthy Is Titan Machinery's Balance Sheet?

The latest balance sheet data shows that Titan Machinery had liabilities of US$1.15b due within a year, and liabilities of US$182.2m falling due after that. Offsetting this, it had US$38.1m in cash and US$153.7m in receivables that were due within 12 months. So its liabilities total US$1.14b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$520.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Titan Machinery would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Titan Machinery has net debt to EBITDA of 4.8 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 8.0 times its interest expense, and its net debt to EBITDA, was quite high, at 4.8. Also relevant is that Titan Machinery has grown its EBIT by a very respectable 22% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Titan Machinery's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. Over the last three years, Titan Machinery barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

We'd go so far as to say Titan Machinery's level of total liabilities was disappointing. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, it seems to us that Titan Machinery's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Case in point: We've spotted 2 warning signs for Titan Machinery you should be aware of.

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.

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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.