Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Wild Brain Ltd. (TSE:WILD) uses debt in its business. But should shareholders worry about its use of debt?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for WildBrain
What is WildBrain’s debt?
The graph below, which you can click on for more details, shows that WildBrain had a debt of C$565.2 million in March 2022; about the same as the previous year. However, since it has a cash reserve of C$60.6 million, its net debt is less, at approximately C$504.6 million.
How healthy is WildBrain’s balance sheet?
According to the last published balance sheet, WildBrain had liabilities of C$291.5 million due within 12 months and liabilities of C$583.1 million due beyond 12 months. In compensation for these obligations, it had cash of 60.6 million Canadian dollars as well as receivables valued at 239.3 million Canadian dollars maturing within 12 months. Thus, its liabilities total C$574.8 million more than the combination of its cash and short-term receivables.
Given that this deficit is actually larger than the company’s market capitalization of C$468.7 million, we think shareholders really should be watching WildBrain’s debt levels, like a parent watching their child go shopping. bike for the first time. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
WildBrain shareholders face the double whammy of a high net debt to EBITDA ratio (5.3) and fairly low interest coverage, as EBIT is only 2.5 times operating expenses. ‘interests. This means that we would consider him to be heavily indebted. On the bright side, WildBrain has grown its EBIT by 48% over the past year. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of managing debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether WildBrain 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.
Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Fortunately for all shareholders, WildBrain has actually produced more free cash flow than EBIT over the past three years. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
We feel some trepidation about WildBrain’s net debt to EBITDA struggle, but we also have some positives to focus on. For example, its EBIT to free cash flow conversion and EBIT growth rate give us some confidence in its ability to manage its debt. We think WildBrain’s debt makes it a bit risky, after looking at the aforementioned data points together. This isn’t necessarily a bad thing, since leverage can increase return on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 2 warning signs for WildBrain (1 is potentially serious) of which you should be aware.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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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.