Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. 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. We note that Boom Logistics Limited (ASX:BOL) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Boom Logistics
What is Boom Logistics debt?
The image below, which you can click on for more details, shows that in December 2021, Boom Logistics had A$17.1 million in debt, up from A$15.6 million in one year. However, he has A$2.94 million in cash to offset this, resulting in a net debt of around A$14.1 million.
A look at the responsibilities of Boom Logistics
According to the latest published balance sheet, Boom Logistics had liabilities of A$76.5 million due within 12 months and liabilities of A$15.9 million due beyond 12 months. As compensation for these obligations, it had cash of 2.94 million Australian dollars as well as receivables valued at 48.4 million Australian dollars maturing within 12 months. Thus, its liabilities total A$41.0 million more than the combination of its cash and short-term receivables.
Boom Logistics has a market capitalization of A$77.0 million, so it could very likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Given that net debt is only 0.57 times EBITDA, it is initially surprising to see that Boom Logistics’ EBIT has a low interest coverage of 2.5 times. So either way, it’s clear that debt levels are not negligible. We also note that Boom Logistics improved its EBIT from last year’s loss to a positive A$6.1 million. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since Boom Logistics will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, a company can only repay its debts with cash, not book profits. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, Boom Logistics has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
When it comes to the balance sheet, the most notable positive for Boom Logistics is the fact that it seems able to convert EBIT to free cash flow with confidence. However, our other observations were not so encouraging. In particular, interest coverage gives us chills. When considering all of the items mentioned above, it seems to us that Boom Logistics is managing its debt quite well. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To this end, you should be aware of the 3 warning signs we spotted with Boom Logistics.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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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.