Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies Greenbrier Companies, Inc. (NYSE: GBX) uses debt. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
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What is the debt of Greenbrier companies?
You can click on the chart below for historical numbers, but it shows Greenbrier companies had $ 1.16 billion in debt in May 2021, up from $ 1.22 billion a year earlier. However, he also had $ 628.2 million in cash, so his net debt is $ 532.0 million.
How strong is the balance sheet of Greenbrier companies?
According to the latest published balance sheet, the Greenbrier companies had liabilities of US $ 763.6 million due within 12 months and liabilities of US $ 965.5 million due beyond 12 months. In compensation for these obligations, it had cash of US $ 628.2 million as well as receivables valued at US $ 349.3 million due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 751.6 million.
While that may sound like a lot, it’s not that bad since Greenbrier Companies has a market capitalization of US $ 1.36 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at your ability to repay your debt.
We measure a company’s debt load relative to its earning capacity 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 costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While Greenbrier Companies’ debt-to-EBITDA ratio (4.4) suggests that it uses some debt, its interest coverage is very low, at 0.42, suggesting high leverage. This is in large part due to the company’s significant depreciation and amortization charges, which arguably means that its EBITDA is a very generous measure of earnings, and its debt may be heavier than it appears. At first glance. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. Worse yet, Greenbrier Companies has seen its EBIT reach 92% in the past 12 months. If the income continues like this for the long haul, there is an incredible chance to pay off that debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Greenbrier Companies’ ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business can only repay its debts with hard cash, not with book profits. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, the Greenbrier companies have experienced substantial total negative free cash flow. While investors no doubt expect this situation to reverse in due course, this clearly means its use of debt is riskier.
Our point of view
To be frank, Greenbrier Companies’ EBIT conversion to free cash flow and its track record of (not) growing its EBIT makes us rather uncomfortable with its debt levels. But at least his total liability level isn’t that bad. After looking at the data points discussed, we believe Greenbrier Companies has too much debt. While some investors like this kind of risky game, it is certainly not our cup of tea. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you should inquire about the 3 warning signs we have identified Greenbrier companies (including 1 which is significant).
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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