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. Importantly, Eastman Kodak Company (NYSE:KODK) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Eastman Kodak's Debt?
You can click the graphic below for the historical numbers, but it shows that Eastman Kodak had US$15.0m of debt in September 2020, down from US$104.0m, one year before. But it also has US$193.0m in cash to offset that, meaning it has US$178.0m net cash.
A Look At Eastman Kodak's Liabilities
According to the last reported balance sheet, Eastman Kodak had liabilities of US$295.0m due within 12 months, and liabilities of US$648.0m due beyond 12 months. Offsetting this, it had US$193.0m in cash and US$155.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$595.0m.
This deficit is considerable relative to its market capitalization of US$628.1m, so it does suggest shareholders should keep an eye on Eastman Kodak's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Eastman Kodak also has more cash than debt, so we're pretty confident it can manage its debt safely.
Importantly, Eastman Kodak's EBIT fell a jaw-dropping 41% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is Eastman Kodak's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Eastman Kodak may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Eastman Kodak saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
While Eastman Kodak does have more liabilities than liquid assets, it also has net cash of US$178.0m. Unfortunately, though, both its struggle EBIT growth rate and its conversion of EBIT to free cash flow leave us concerned about Eastman Kodak So despite the cash, we do think it carries some risks. 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. For instance, we've identified 3 warning signs for Eastman Kodak (2 are concerning) you should be aware of.
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.
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Eastman Kodak Company provides hardware, software, consumables, and services to customers in the commercial print, packaging, publishing, manufacturing, and entertainment markets worldwide.
Mediocre balance sheet and slightly overvalued.