David Iben put it well when he said, âVolatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We can see that Greif, Inc. (NYSE: GEF) uses debt in its business. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. 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 must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first look at cash and debt levels together.
What is Greif’s net debt?
The image below, which you can click for more details, shows Greif owed US $ 2.28 billion in debt at the end of July 2021, a reduction from US $ 2.69 billion. over a year. However, because it has a cash reserve of US $ 99.8 million, its net debt is less, at around US $ 2.18 billion.
NYSE: GEF Debt to Equity History October 14, 2021
A look at Greif’s responsibilities
We can see from the most recent balance sheet that Greif had liabilities of US $ 1.24 billion maturing within one year and liabilities of US $ 2.96 billion maturing beyond that. In compensation for these obligations, he had cash of US $ 99.8 million as well as receivables valued at US $ 834.7 million within 12 months. It therefore has liabilities totaling $ 3.26 billion more than its cash and short-term receivables combined.
This deficit is sizable compared to its market capitalization of $ 3.36 billion, so he suggests shareholders keep an eye on Greif’s use of debt. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.
We measure a company’s debt load relative to its earning power 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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Greif’s debt is 3.1 times its EBITDA and its EBIT covers its interest expense 4.6 times. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. Greif increased its EBIT by 7.2% last year. It’s far from incredible, but it’s a good thing when it comes to paying down debt. The balance sheet is clearly the area to focus on when analyzing debt. But it’s future profits, more than anything, that will determine Greif’s ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business can only repay its debts with hard cash, not with book profits. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Greif has generated strong free cash flow equivalent to 64% 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
Greif’s level of total liabilities and net debt to EBITDA certainly weighs on him, in our view. But he seems to be able to convert EBIT into free cash flow without too many problems. We think Greif’s debt makes it a bit risky, having looked at 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. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. To do this, you need to know the 1 warning sign we spotted with Greif.
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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