David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Cushman & Wakefield plc (NYSE:CWK) makes use of debt. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Cushman & Wakefield's Debt?
The image below, which you can click on for greater detail, shows that at March 2021 Cushman & Wakefield had debt of US$3.25b, up from US$2.81b in one year. However, because it has a cash reserve of US$1.02b, its net debt is less, at about US$2.24b.
How Healthy Is Cushman & Wakefield's Balance Sheet?
The latest balance sheet data shows that Cushman & Wakefield had liabilities of US$1.98b due within a year, and liabilities of US$4.05b falling due after that. Offsetting this, it had US$1.02b in cash and US$1.49b in receivables that were due within 12 months. So it has liabilities totalling US$3.52b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$4.26b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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.
Weak interest cover of 0.44 times and a disturbingly high net debt to EBITDA ratio of 7.2 hit our confidence in Cushman & Wakefield like a one-two punch to the gut. The debt burden here is substantial. Worse, Cushman & Wakefield's EBIT was down 54% 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 it is future earnings, more than anything, that will determine Cushman & Wakefield'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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Cushman & Wakefield produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
On the face of it, Cushman & Wakefield's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, it seems to us that Cushman & Wakefield's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. Even though Cushman & Wakefield lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.
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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