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. We can see that Broadridge Financial Solutions, Inc. (NYSE:BR) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Broadridge Financial Solutions's Debt?
As you can see below, Broadridge Financial Solutions had US$1.74b of debt at March 2021, down from US$2.08b a year prior. However, it does have US$356.8m in cash offsetting this, leading to net debt of about US$1.38b.
How Strong Is Broadridge Financial Solutions' Balance Sheet?
According to the last reported balance sheet, Broadridge Financial Solutions had liabilities of US$1.00b due within 12 months, and liabilities of US$2.59b due beyond 12 months. Offsetting these obligations, it had cash of US$356.8m as well as receivables valued at US$871.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.37b.
Given Broadridge Financial Solutions has a humongous market capitalization of US$20.0b, 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.
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.
Broadridge Financial Solutions has a low net debt to EBITDA ratio of only 1.4. And its EBIT easily covers its interest expense, being 13.1 times the size. So we're pretty relaxed about its super-conservative use of debt. Also positive, Broadridge Financial Solutions grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Broadridge Financial Solutions can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Broadridge Financial Solutions generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Happily, Broadridge Financial Solutions's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Overall, we don't think Broadridge Financial Solutions is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Broadridge Financial Solutions , and understanding them should be part of your investment process.
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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