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. ‘ 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. We note that Terex Company (NYSE: TEX) has a debt on its balance sheet. But the real question is whether this debt makes the business risky.
When Is Debt a Problem?
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. If things really go wrong, lenders can take over the business. 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. Of course, many companies use debt to finance their growth without 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.
What is Terex’s debt?
The graph below, which you can click for more details, shows that Terex had $ 1.17 billion in debt as of December 2020; about the same as the year before. However, he also had $ 665.0 million in cash, so his net debt is $ 508.2 million.
How strong is Terex’s balance sheet?
The latest balance sheet data shows that Terex had $ 723.3 million in liabilities due within one year, and $ 1.39 billion in liabilities due thereafter. In compensation for these obligations, it had cash of US $ 665.0 million as well as receivables valued at US $ 476.4 million due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 968.9 million.
While that might sound like a lot, it’s not that bad since Terex has a market cap of $ 3.25 billion, so it could likely strengthen its balance sheet by raising capital if needed. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While we’re not worried about Terex’s 4.1 net debt to EBITDA ratio, we do think its ultra-low 1.2 times interest coverage is a sign of high leverage. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. Worse, Terex’s EBIT was down 78% from last year. If profits continue to follow this path, it will be more difficult to pay off this debt than to convince us to run a marathon in the rain. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Terex can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Terex’s free cash flow has been 28% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.
Our point of view
To be frank, Terex’s interest coverage and its history of (not) growing its EBIT make us rather uncomfortable with its level of debt. But at least his total liability level isn’t that bad. We’re pretty clear that we consider Terex to be really quite risky, because of the health of its balance sheet. For this reason, we are quite cautious on the stock, and we believe that shareholders should closely monitor its liquidity. 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. For example, Terex has 5 warning signs (and 1 which is a bit unpleasant) we think you should know.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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