David Iben put it right when he said: “Volatility is not a risk that is close to our hearts. What matters to us is to avoid the permanent loss of capital. So it can be obvious that you need to factor in debt, when you think about how risky a given stock is because too much debt can sink a business. Like many other companies Greif, Inc. (NYSE: GEF) uses debt. But the most important question is: what is the risk that this debt creates?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a business cannot easily repay it, 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 painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, many companies use debt to finance growth without any negative consequences. 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 analysis for Greif
What is Greif’s net debt?
You can click on the graph below for historical numbers, but it shows Greif had $ 2.55 billion in debt in January 2021, up from $ 2.86 billion a year earlier. However, because it has a cash reserve of US $ 102.8 million, its net debt is lower, at around US $ 2.45 billion.
How healthy is Greif’s track record?
The latest balance sheet data shows that Greif had liabilities of US $ 990.5 million due within one year, and liabilities of US $ 3.29 billion thereafter. On the other hand, he had US $ 102.8 million in cash and US $ 679.7 million in receivables due within one year. Its liabilities therefore total $ 3.50 billion more than the combination of its cash and short-term receivables.
Given that this deficit is actually greater than the company’s market cap of US $ 2.95 billion, we think shareholders should really watch Greif’s debt levels, like a parent watching their child do. cycling for the first time. In theory, extremely heavy dilution would be required if the company was forced to repay its debts by raising capital at the current share price.
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 ) cover his interests. costs (interest coverage). In this way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Greif has a debt to EBITDA ratio of 3.9 and its EBIT has covered its interest expense 3.5 times. This suggests that while debt levels are significant, we would stop before calling them problematic. Another concern for investors could be that Greif’s EBIT fell 17% last year. If this is the way things continue to manage the debt burden, it will be like delivering hot coffees on a pogo stick. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Greif can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
But our last consideration is also important, because a business cannot pay its debt with profits on paper; he needs cash. We therefore always check the part of this EBIT which translates into free cash flow. Over the past three years, Greif has produced strong free cash flow equivalent to 57% of its EBIT, which we expected. This hard, cold cash flow means he can reduce his debt whenever he wants.
Our point of view
To be frank, Greif’s total liability level and his track record of (not) growing his EBIT make us pretty uncomfortable with his leverage levels. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Overall, it seems to us that Greif’s balance sheet is really a risk for the company. For this reason, we are fairly cautious on the stock and believe that shareholders should closely monitor its liquidity. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. We have identified 4 warning signs with Greif (at least 1 which cannot be ignored), and understanding them should be part of your investment process.
If you want to invest in companies that can generate profits without the burden of debt, take a look at this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim 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 information. Simply Wall St has no position in the mentioned stocks.
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