Is Custom Truck One Source (NYSE:CTOS) A Risky Investment?

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. We can see that Custom Truck One Source, Inc. (NYSE:CTOS) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Custom Truck One Source

What Is Custom Truck One Source's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Custom Truck One Source had US$2.49b of debt, an increase on US$2.02b, over one year. Net debt is about the same, since the it doesn't have much cash.

A Look At Custom Truck One Source's Liabilities

Zooming in on the latest balance sheet data, we can see that Custom Truck One Source had liabilities of US$1.10b due within 12 months and liabilities of US$1.64b due beyond that. Offsetting these obligations, it had cash of US$8.44m as well as receivables valued at US$188.0m due within 12 months. So it has liabilities totalling US$2.55b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the US$1.19b 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'd watch its balance sheet closely, without a doubt. After all, Custom Truck One Source would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Custom Truck One Source shareholders face the double whammy of a high net debt to EBITDA ratio (13.6), and fairly weak interest coverage, since EBIT is just 0.82 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, Custom Truck One Source's EBIT was down 30% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that 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 Custom Truck One Source'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Custom Truck One Source burned a lot of cash. 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 Custom Truck One Source's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. It looks to us like Custom Truck One Source carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. Given the risks around Custom Truck One Source's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.

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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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.