Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Tejon Ranch Co. (NYSE:TRC) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Tejon Ranch Carry?
As you can see below, Tejon Ranch had US$59.6m of debt at March 2021, down from US$66.6m a year prior. However, it does have US$52.3m in cash offsetting this, leading to net debt of about US$7.27m.
How Strong Is Tejon Ranch's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Tejon Ranch had liabilities of US$15.6m due within 12 months and liabilities of US$75.5m due beyond that. Offsetting this, it had US$52.3m in cash and US$1.32m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$37.4m.
Given Tejon Ranch has a market capitalization of US$399.1m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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 Tejon Ranch'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.
Over 12 months, Tejon Ranch made a loss at the EBIT level, and saw its revenue drop to US$39m, which is a fall of 22%. To be frank that doesn't bode well.
Not only did Tejon Ranch's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at US$5.9m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of US$1.1m. So to be blunt we do think it is risky. For riskier companies like Tejon Ranch I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
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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What are the risks and opportunities for Tejon Ranch?
Trading at 77.2% below our estimate of its fair value
Earnings are forecast to decline by an average of 2.8% per year for the next 3 years
Profit margins (8%) are lower than last year (23%)
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. 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.
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