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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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. We can see that U.S. Silica Holdings, Inc. (NYSE:SLCA) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is U.S. Silica Holdings’s Net Debt?
As you can see below, at the end of March 2019, U.S. Silica Holdings had US$1.26b of debt, up from US$511.5m a year ago. Click the image for more detail. However, because it has a cash reserve of US$161.6m, its net debt is less, at about US$1.10b.
A Look At U.S. Silica Holdings’s Liabilities
According to the last reported balance sheet, U.S. Silica Holdings had liabilities of US$327.1m due within 12 months, and liabilities of US$1.73b due beyond 12 months. Offsetting this, it had US$161.6m in cash and US$242.3m in receivables that were due within 12 months. So it has liabilities totalling US$1.65b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the US$962.1m 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, U.S. Silica Holdings would likely require a major re-capitalisation if it had to pay its creditors today. Since U.S. Silica Holdings does have net debt, we think it is worthwhile for shareholders to keep an eye on the balance sheet, over time.
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.
While U.S. Silica Holdings’s debt to EBITDA ratio (4.31) suggests that it uses debt fairly modestly, its interest cover is very weak, at 1.09. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, U.S. Silica Holdings’s EBIT was down 57% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if U.S. Silica Holdings 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, U.S. Silica Holdings saw substantial negative free cash flow, in total. 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, U.S. Silica Holdings’s EBIT growth rate 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. And furthermore, its interest cover also fails to instill confidence. It looks to us like U.S. Silica Holdings carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we’d probably give this stock a wide berth. Given the risks around U.S. Silica Holdings’s use of debt, the sensible thing to do is to check if insiders have been unloading the stock.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.