Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Eastman Kodak Company (NYSE:KODK) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Eastman Kodak's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2021 Eastman Kodak had debt of US$250.0m, up from US$15.0m in one year. However, it does have US$380.0m in cash offsetting this, leading to net cash of US$130.0m.
A Look At Eastman Kodak's Liabilities
We can see from the most recent balance sheet that Eastman Kodak had liabilities of US$312.0m falling due within a year, and liabilities of US$884.0m due beyond that. Offsetting these obligations, it had cash of US$380.0m as well as receivables valued at US$169.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$647.0m.
This deficit casts a shadow over the US$313.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Eastman Kodak would likely require a major re-capitalisation if it had to pay its creditors today. Eastman Kodak boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
Pleasingly, Eastman Kodak is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 174% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Eastman Kodak will need earnings to service that debt. 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. During the last three years, Eastman Kodak burned a lot of cash. 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.
Although Eastman Kodak's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$130.0m. And we liked the look of last year's 174% year-on-year EBIT growth. Despite the cash, we do find Eastman Kodak's level of total liabilities concerning, so we're not particularly comfortable with the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Eastman Kodak has 2 warning signs (and 1 which is potentially serious) we think you should know about.
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.
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.