Here's Why TravelCenters of America (NASDAQ:TA) Has A Meaningful Debt Burden

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that TravelCenters of America Inc. (NASDAQ:TA) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for TravelCenters of America

What Is TravelCenters of America's Net Debt?

As you can see below, TravelCenters of America had US$524.4m of debt, at September 2022, which is about the same as the year before. You can click the chart for greater detail. However, it also had US$467.3m in cash, and so its net debt is US$57.0m.

How Strong Is TravelCenters of America's Balance Sheet?

According to the last reported balance sheet, TravelCenters of America had liabilities of US$640.5m due within 12 months, and liabilities of US$2.22b due beyond 12 months. On the other hand, it had cash of US$467.3m and US$219.4m worth of receivables due within a year. So its liabilities total US$2.17b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$713.9m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, TravelCenters of America would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 0.18 and interest cover of 4.8 times, it seems to us that TravelCenters of America is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Importantly, TravelCenters of America grew its EBIT by 94% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine TravelCenters of America'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, TravelCenters of America produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

While TravelCenters of America's level of total liabilities has us nervous. For example, its EBIT growth rate and net debt to EBITDA give us some confidence in its ability to manage its debt. We think that TravelCenters of America's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for TravelCenters of America you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.