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 whether you will suffer a permanent loss of capital”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Mostly, Nutrien Ltd. (TSE: NTR) carries debt. But does this debt worry shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest review for Nutrien
How much debt does Nutrien have?
You can click on the graph below for the historical figures, but it shows that Nutrien had a debt of US $ 10.3 billion in March 2021, up from US $ 14.0 billion a year earlier. However, he also had $ 712.0 million in cash, so his net debt is $ 9.59 billion.
A look at Nutrien’s responsibilities
According to the latest published balance sheet, Nutrien had liabilities of US $ 9.27 billion due within 12 months and liabilities of US $ 16.3 billion due beyond 12 months. In compensation for these obligations, he had cash of US $ 712.0 million as well as receivables valued at US $ 4.23 billion due within 12 months. It therefore has liabilities totaling US $ 20.6 billion more than its cash and short-term receivables combined.
While that might sound like a lot, it’s not that big of a deal since Nutrien has a massive market cap of US $ 36.8 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky.
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). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Nutrien has a debt / EBITDA ratio of 2.8 and his EBIT covers his interest expense 3.8 times. This suggests that while debt levels are significant, we would stop calling them problematic. Even more troubling is the fact that Nutrien has actually let his EBIT decline by 7.0% over the past year. If this earnings trend continues, the company will face an uphill battle to repay its debt. There is no doubt that we learn the most about debt from the balance sheet. But it’s future profits, more than anything, that will determine Nutrien’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Nutrien has generated strong free cash flow equivalent to 71% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Neither Nutrien’s ability to increase its EBIT nor its interest coverage gave us confidence in its ability to take on more debt. But the good news is that it seems to be able to easily convert EBIT into free cash flow. We think Nutrien’s debt makes it a bit risky, after considering the aforementioned data points together. Not all risks are bad, as they can increase stock price returns if they are profitable, but this risk of leverage is worth keeping in mind. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. To do this, you need to know the 4 warning signs we spotted with Nutrien.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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