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.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company’s use of debt, we first look at cash and debt together.
What Is Broadridge Financial Solutions’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Broadridge Financial Solutions had US$1.47b of debt, an increase on US$1.05b, over one year. However, it also had US$273.6m in cash, and so its net debt is US$1.20b.
How Strong Is Broadridge Financial Solutions’s Balance Sheet?
We can see from the most recent balance sheet that Broadridge Financial Solutions had liabilities of US$802.6m falling due within a year, and liabilities of US$1.95b due beyond that. On the other hand, it had cash of US$273.6m and US$664.0m worth of receivables due within a year. So it has liabilities totalling US$1.82b more than its cash and near-term receivables, combined.
Given Broadridge Financial Solutions has a humongous market capitalization of US$14.8b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Broadridge Financial Solutions’s net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 15.7 times the size. So we’re pretty relaxed about its super-conservative use of debt. The good news is that Broadridge Financial Solutions has increased its EBIT by 9.2% over twelve months, which should ease any concerns about debt repayment. 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 produced sturdy free cash flow equating to 79% 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.
Broadridge Financial Solutions’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. And that’s just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Broadridge Financial Solutions’s use of debt seems quite reasonable and we’re not concerned about it. After all, sensible leverage can boost returns on equity. We’d be motivated to research the stock further if we found out that Broadridge Financial Solutions insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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