David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Mostly, Limited choir (NZSE: CNU) is in debt. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
Discover our latest analyzes for Chorus
What is Chorus’ net debt?
As you can see below, Chorus had NZ$3.04 billion in debt as of December 2021, up from NZ$3.30 billion the previous year. However, he has NZ$84.0 million in cash to offset this, resulting in a net debt of around NZ$2.95 billion.
A look at Chorus’ responsibilities
Zooming in on the latest balance sheet data, we can see that Chorus had liabilities of NZ$477.0 million due within 12 months and liabilities of NZ$4.34 billion due beyond. On the other hand, it had liquid assets of NZ$84.0 million and NZ$146.0 million of receivables at less than one year. Thus, its liabilities total NZ$4.59 billion more than the combination of its cash and short-term receivables.
Given that this deficit is actually greater than the company’s market capitalization of NZ$3.34 billion, we think shareholders really should be watching Chorus’ debt levels, like a parent watching their child. riding a bike for the first time. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Low interest coverage of 1.6 times and an abnormally high net debt to EBITDA ratio of 5.0 shook our confidence in Chorus like a punch in the gut. This means that we would consider him to be heavily indebted. Notably, Chorus’ EBIT has been fairly flat over the past year, which isn’t ideal given the leverage. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Chorus can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Chorus has experienced significant negative free cash flow, in total. While investors no doubt expect a reversal of this situation in due course, it clearly means that its use of debt is more risky.
Our point of view
At first glance, Chorus’ interest coverage left us hesitant about the stock, and its EBIT-to-free-cash-flow conversion was no more appealing than the single empty restaurant on the busiest night in the world. ‘year. That said, its ability to grow its EBIT is not such a concern. After reviewing the data points discussed, we believe that Chorus has too much debt. That kind of risk is acceptable to some, but it certainly doesn’t float our boat. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 2 warning signs for Chorus you should be aware.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.