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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.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Atlas Air Worldwide Holdings, Inc. (NASDAQ:AAWW) does use debt in its business. But the real question is whether this debt is making the company risky.
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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
View our latest analysis for Atlas Air Worldwide Holdings
What Is Atlas Air Worldwide Holdings’s Net Debt?
As you can see below, at the end of March 2019, Atlas Air Worldwide Holdings had US$2.41b of debt, up from US$2.27b a year ago. Click the image for more detail. However, it also had US$165.9m in cash, and so its net debt is US$2.24b.
How Strong Is Atlas Air Worldwide Holdings’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Atlas Air Worldwide Holdings had liabilities of US$936.7m due within 12 months and liabilities of US$3.04b due beyond that. Offsetting this, it had US$165.9m in cash and US$255.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.56b.
This deficit casts a shadow over the US$1.11b company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt At the end of the day, Atlas Air Worldwide Holdings would probably need a major re-capitalization if its creditors were to demand repayment. Because it carries more debt than cash, we think it’s worth watching Atlas Air Worldwide Holdings’s balance sheet over time.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Atlas Air Worldwide Holdings’s debt is only 3.91 times its EBITDA, and its EBIT cover its interest expense 2.71 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. On a slightly more positive note, Atlas Air Worldwide Holdings grew its EBIT at 16% over the last year, further increasing its ability to manage debt. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Atlas Air Worldwide Holdings 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Atlas Air Worldwide Holdings 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.
Our View
To be frank both Atlas Air Worldwide Holdings’s conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it’s pretty decent at growing its EBIT; that’s encouraging. Taking into account all the aforementioned factors, it looks like Atlas Air Worldwide Holdings has too much debt. That sort of riskiness is ok for some, but it certainly doesn’t float our boat. Over time, share prices tend to follow earnings per share, so if you’re interested in Atlas Air Worldwide Holdings, you may well want to click here to check an interactive graph of its earnings per share history.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.