Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a 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. We notice that Waste Connections, Inc. (NYSE: WCN) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. 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, 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.
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What is the debt of Waste Connections?
The image below, which you can click for more details, shows Waste Connections owed $ 4.78 billion in debt at the end of March 2021, a reduction from $ 5.28 billion. US over one year. On the other hand, it has $ 743.5 million in cash, resulting in net debt of around $ 4.04 billion.
How healthy is Waste Connections’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Waste Connections had a liability of US $ 1.11 billion owed within 12 months and a liability of US $ 5.99 billion owed beyond that. On the other hand, he had $ 743.5 million in cash and $ 608.8 million in receivables due within one year. It therefore has liabilities totaling US $ 5.75 billion more than its cash and short-term receivables combined.
Given that Waste Connections has a whopping market cap of US $ 31.4 billion, it’s hard to believe that these liabilities pose a big threat. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time.
We use two main ratios to tell us about leverage versus earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we consider debt versus earnings with and without amortization charges.
Waste Connections’ net debt stands at a very reasonable level of 2.4 times its EBITDA, while its EBIT covered only 5.6 times its interest expense last year. While this doesn’t worry us too much, it does suggest that the interest payments are somewhat of a burden. Notably, Waste Connections’ EBIT has been fairly stable over the past year. Ideally, he can reduce his debt load by starting profit growth. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Waste Connections 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, Waste Connections has recorded free cash flow totaling 94% of its EBIT, which is higher than what we normally expected. This positions it well to repay debt if it is desirable.
Our point of view
Waste Connections’ EBIT conversion into free cash flow suggests she can manage her debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. But, on a darker note, we’re a little concerned about its net debt to EBITDA. All these things considered, it looks like Waste Connections can comfortably manage its current debt levels. Of course, while this leverage can improve returns on equity, it comes with more risk, so it’s worth keeping an eye out for. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 4 warning signs for waste connections which you should know before investing here.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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