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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.’ 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. Corporación América Airports S.A. (NYSE:CAAP) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Corporación América Airports’s Net Debt?
The image below, which you can click on for greater detail, shows that Corporación América Airports had debt of US$1.14b at the end of March 2019, a reduction from US$1.23b over a year. However, it does have US$309.1m in cash offsetting this, leading to net debt of about US$828.2m.
How Healthy Is Corporación América Airports’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Corporación América Airports had liabilities of US$448.0m due within 12 months and liabilities of US$2.14b due beyond that. On the other hand, it had cash of US$309.1m and US$193.1m worth of receivables due within a year. So it has liabilities totalling US$2.09b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the US$1.32b company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt After all, Corporación América Airports would likely require a major re-capitalisation if it had to pay its creditors today. Because it carries more debt than cash, we think it’s worth watching Corporación América Airports’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). 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).
Corporación América Airports’s net debt is sitting at a very reasonable 1.81 times its EBITDA, while its EBIT covered its interest expense just 4.54 times last year. While that doesn’t worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Corporación América Airports’s EBIT fell a jaw-dropping 30% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Corporación América Airports’s ability to maintain a healthy balance sheet going forward. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Corporación América Airports’s free cash flow amounted to 22% of its EBIT, less than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
On the face of it, Corporación América Airports’s level of total liabilities left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability handle its debt, based on its EBITDA, isn’t such a worry. We should also note that Infrastructure industry companies like Corporación América Airports commonly do use debt without problems. After considering the datapoints discussed, we think Corporación América Airports 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 Corporación América Airports, you may well want to click here to check an interactive graph of its earnings per share history.
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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If you spot an error that warrants correction, please contact the editor at email@example.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.