Titan Machinery (NASDAQ:TITN) Seems To Use Debt Rather Sparingly

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 Titan Machinery Inc. (NASDAQ:TITN) 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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Titan Machinery

How Much Debt Does Titan Machinery Carry?

You can click the graphic below for the historical numbers, but it shows that as of January 2022 Titan Machinery had US$203.7m of debt, an increase on US$194.8m, over one year. However, because it has a cash reserve of US$146.1m, its net debt is less, at about US$57.5m.

A Look At Titan Machinery's Liabilities

According to the last reported balance sheet, Titan Machinery had liabilities of US$374.7m due within 12 months, and liabilities of US$136.7m due beyond 12 months. Offsetting this, it had US$146.1m in cash and US$94.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$271.0m.

While this might seem like a lot, it is not so bad since Titan Machinery has a market capitalization of US$531.8m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

Titan Machinery's net debt is only 0.51 times its EBITDA. And its EBIT covers its interest expense a whopping 17.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Titan Machinery grew its EBIT by 126% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Titan Machinery 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 we always check how much of that EBIT is translated into free cash flow. Over the last three years, Titan Machinery actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Titan Machinery's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at the bigger picture, we think Titan Machinery's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. To that end, you should be aware of the 1 warning sign we've spotted with Titan Machinery .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.