Columbus McKinnon (NASDAQ:CMCO) seems to be using debt quite wisely

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 seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Columbus McKinnon Society (NASDAQ:CMCO) is in debt. But does this debt worry shareholders?

Why is debt risky?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

What is Columbus McKinnon’s net debt?

You can click on the graph below for historical numbers, but it shows that in June 2022, Columbus McKinnon had $490.5 million in debt, up from $461.9 million, on a year. However, since he has a cash reserve of $89.6 million, his net debt is less, at around $400.9 million.

NasdaqGS: CMCO Debt to Equity History October 10, 2022

How healthy is Columbus McKinnon’s balance sheet?

The latest balance sheet data shows that Columbus McKinnon had liabilities of $219.3 million due within the year, and liabilities of $640.3 million due thereafter. In compensation for these obligations, it had cash of US$89.6 million as well as receivables valued at US$137.7 million and maturing within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $632.3 million.

This is a mountain of leverage compared to its market capitalization of US$711.1 million. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.

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). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Columbus McKinnon’s debt is 3.1 times its EBITDA, and its EBIT covers its interest expense 4.2 times. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. On the bright side, Columbus McKinnon has grown its EBIT by 100% over the past year. Like a mother’s loving embrace of a newborn, this kind of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when analyzing debt. But future earnings, more than anything, will determine Columbus McKinnon’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a company can only repay its debts with cold hard cash, not with book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Columbus McKinnon has actually produced more free cash flow than EBIT. There’s nothing better than incoming money to stay in the good books of your lenders.

Our point of view

Columbus McKinnon’s conversion of EBIT to free cash flow was a real benefit in this analysis, as was its EBIT growth rate. On the other hand, its level of total liabilities makes us a little less comfortable about its indebtedness. Given this range of data points, we believe Columbus McKinnon is in a good position to manage its level of leverage. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that Columbus McKinnon shows 1 warning sign in our investment analysis you should know…

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.

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.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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