Here's Why Top Ships (NASDAQ:TOPS) Is Weighed Down By Its Debt Load

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Top Ships Inc. (NASDAQ:TOPS) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Top Ships

What Is Top Ships's Debt?

You can click the graphic below for the historical numbers, but it shows that Top Ships had US$155.8m of debt in June 2021, down from US$278.7m, one year before. However, it does have US$8.39m in cash offsetting this, leading to net debt of about US$147.4m.

How Healthy Is Top Ships' Balance Sheet?

We can see from the most recent balance sheet that Top Ships had liabilities of US$53.1m falling due within a year, and liabilities of US$174.9m due beyond that. Offsetting these obligations, it had cash of US$8.39m as well as receivables valued at US$57.0k due within 12 months. So it has liabilities totalling US$219.5m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$43.4m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Top Ships would probably need a major re-capitalization if its creditors were to demand repayment.

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).

While Top Ships's debt to EBITDA ratio (4.9) suggests that it uses some debt, its interest cover is very weak, at 1.2, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Given the debt load, it's hardly ideal that Top Ships's EBIT was pretty flat over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Top Ships can strengthen its balance sheet over time. 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, Top Ships 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 Top Ships's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like Top Ships has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. For example, we've discovered 2 warning signs for Top Ships that you should be aware of before investing here.

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.