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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Delek US Holdings, Inc. (NYSE:DK) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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.
What Is Delek US Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2020 Delek US Holdings had debt of US$2.64b, up from US$2.02b in one year. However, it also had US$807.9m in cash, and so its net debt is US$1.83b.
How Healthy Is Delek US Holdings' Balance Sheet?
The latest balance sheet data shows that Delek US Holdings had liabilities of US$1.81b due within a year, and liabilities of US$3.29b falling due after that. On the other hand, it had cash of US$807.9m and US$739.6m worth of receivables due within a year. So it has liabilities totalling US$3.56b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the US$1.58b 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 definitely think shareholders need to watch this one closely. After all, Delek US Holdings would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Delek US Holdings'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.
In the last year Delek US Holdings had a loss before interest and tax, and actually shrunk its revenue by 19%, to US$7.7b. We would much prefer see growth.
While Delek US Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping US$360m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$644m in negative free cash flow over the last year. That means it's on the risky side of things. 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 instance, we've identified 3 warning signs for Delek US Holdings (1 shouldn't be ignored) you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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