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. As with many other companies The Andersons, Inc. (NASDAQ:ANDE) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Andersons Carry?
The image below, which you can click on for greater detail, shows that at June 2019 Andersons had debt of US$1.46b, up from US$659.3m in one year. Net debt is about the same, since the it doesn’t have much cash.
How Strong Is Andersons’s Balance Sheet?
The latest balance sheet data shows that Andersons had liabilities of US$1.30b due within a year, and liabilities of US$1.25b falling due after that. On the other hand, it had cash of US$11.1m and US$712.3m worth of receivables due within a year. So its liabilities total US$1.83b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$808.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Andersons 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.
Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 7.8 hit our confidence in Andersons like a one-two punch to the gut. The debt burden here is substantial. The good news is that Andersons grew its EBIT a smooth 57% over the last twelve months. 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Andersons’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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Andersons 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.
On the face of it, Andersons’s conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it’s pretty decent at growing its EBIT; that’s encouraging. Overall, it seems to us that Andersons’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. Given our concerns about Andersons’s debt levels, it seems only prudent to check if insiders have been ditching 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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