David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Universal Logistics Holdings, Inc. (NASDAQ:ULH) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Universal Logistics Holdings's Net Debt?
As you can see below, Universal Logistics Holdings had US$429.0m of debt at April 2021, down from US$478.8m a year prior. On the flip side, it has US$18.3m in cash leading to net debt of about US$410.7m.
How Strong Is Universal Logistics Holdings' Balance Sheet?
According to the last reported balance sheet, Universal Logistics Holdings had liabilities of US$278.9m due within 12 months, and liabilities of US$516.0m due beyond 12 months. Offsetting these obligations, it had cash of US$18.3m as well as receivables valued at US$291.4m due within 12 months. So it has liabilities totalling US$485.1m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$682.1m, so it does suggest shareholders should keep an eye on Universal Logistics Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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).
Universal Logistics Holdings has a debt to EBITDA ratio of 2.5 and its EBIT covered its interest expense 6.5 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Unfortunately, Universal Logistics Holdings saw its EBIT slide 5.5% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Universal Logistics Holdings 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Universal Logistics Holdings recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While Universal Logistics Holdings's EBIT growth rate makes us cautious about it, its track record of staying on top of its total liabilities is no better. At least its interest cover gives us reason to be optimistic. Taking the abovementioned factors together we do think Universal Logistics Holdings's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Universal Logistics Holdings you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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