The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. Importantly, Broadridge Financial Solutions, Inc. (NYSE:BR) does carry debt. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Broadridge Financial Solutions’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2019 Broadridge Financial Solutions had US$1.85b of debt, an increase on US$1.19b, over one year. However, because it has a cash reserve of US$234.4m, its net debt is less, at about US$1.61b.
A Look At Broadridge Financial Solutions’s Liabilities
According to the last reported balance sheet, Broadridge Financial Solutions had liabilities of US$1.12b due within 12 months, and liabilities of US$2.13b due beyond 12 months. Offsetting this, it had US$234.4m in cash and US$616.0m in receivables that were due within 12 months. So it has liabilities totalling US$2.41b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Broadridge Financial Solutions has a huge market capitalization of US$10.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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.
We’d say that Broadridge Financial Solutions’s moderate net debt to EBITDA ratio ( being 1.9), indicates prudence when it comes to debt. And its commanding EBIT of 11.9 times its interest expense, implies the debt load is as light as a peacock feather. Importantly Broadridge Financial Solutions’s EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish debt. 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 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Broadridge Financial Solutions generated free cash flow amounting to a very robust 86% of its EBIT, more than we’d expect. That positions it well to pay down debt if desirable to do so.
Happily, Broadridge Financial Solutions’s impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And that’s just the beginning of the good news since its interest cover is also very heartening. Taking all this data into account, it seems to us that Broadridge Financial Solutions takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. Consider for instance, the ever-present spectre of investment risk. We’ve identified 2 warning signs with Broadridge Financial Solutions , and understanding them should be part of your investment process.
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.
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