Brink's (NYSE:BCO) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, The Brink's Company (NYSE:BCO) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Brink's

How Much Debt Does Brink's Carry?

The image below, which you can click on for greater detail, shows that at March 2023 Brink's had debt of US$3.16b, up from US$2.91b in one year. However, it does have US$831.7m in cash offsetting this, leading to net debt of about US$2.33b.

A Look At Brink's' Liabilities

According to the last reported balance sheet, Brink's had liabilities of US$1.60b due within 12 months, and liabilities of US$4.05b due beyond 12 months. Offsetting this, it had US$831.7m in cash and US$884.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.93b.

Given this deficit is actually higher than the company's market capitalization of US$3.21b, we think shareholders really should watch Brink's's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Brink's has a debt to EBITDA ratio of 3.7 and its EBIT covered its interest expense 3.0 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Looking on the bright side, Brink's boosted its EBIT by a silky 32% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Brink's'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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, Brink's produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Brink's's EBIT growth rate was a real positive on this analysis, as was its conversion of EBIT to free cash flow. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. When we consider all the factors mentioned above, we do feel a bit cautious about Brink's's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Be aware that Brink's is showing 4 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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.