Acadian Timber (TSE: DNA) Takes Risks With Its Debt Use
David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies Acadian Timber Corp. (IS: DNA) uses the debt. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.
What is Acadian Timber’s net debt?
As you can see below, Acadian Timber had C $ 101.2 million in debt as of December 2020, which is roughly the same as the year before. You can click on the graph for more details. On the other hand, he has C $ 10.3 million in cash, resulting in net debt of around C $ 90.9 million.
Is Acadian Timber’s Track Record Healthy?
We can see from the most recent balance sheet that Acadian Timber had C $ 13.5 million liabilities due within one year and C $ 206.7 million liabilities due. beyond. In return, he had C $ 10.3 million in cash and C $ 8.15 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by C $ 201.8 million.
This is a mountain of leverage compared to its market capitalization of C $ 301.7 million. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. 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).
Acadian Timber has a debt to EBITDA ratio of 4.3 and its EBIT has covered its interest expense 4.8 times. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. Unfortunately, Acadian Timber has seen its EBIT drop 6.3% in the past twelve months. If incomes continue to decline, managing that debt will be difficult, like delivering hot soup on a unicycle. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Acadian Timber’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals are thinking, you might find this free report on analysts’ earnings forecasts Be interesting.
Finally, a business can only repay its debts with hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Acadian Timber has recorded free cash flow of 50% of its EBIT over the past three years, which is close to normal, as free cash flow excludes interest and taxes. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
Thinking back to Acadian Timber’s attempt to manage its debt for its EBITDA, we are certainly not enthusiastic. That said, its ability to convert EBIT to free cash flow is not that much of a concern. Once you consider all of the above factors together, it seems to us that Acadian Timber’s debt makes it a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. 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 off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Acadian wood (1 of which is a bit unpleasant!) to know.
If, after all of this, you’re more interested in a fast-growing company with a rock-solid balance sheet, then check out our list of cash net growth stocks without delay.
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