David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We notice that Dorian LPG Ltd. (NYSE:LPG) has debt on its balance sheet. But does this debt worry shareholders?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.
What is DorianG’s debt?
As you can see below, DorianG had $576.6 million in debt as of December 2021, up from $611.7 million the previous year. However, he has $115.8 million in cash to offset this, resulting in a net debt of approximately $460.8 million.
A look at DorianG’s responsibilities
The latest balance sheet data shows that DorianG had liabilities of $94.9 million due within the year, and liabilities of $509.2 million due thereafter. In return, it had $115.8 million in cash and $47.5 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $440.8 million.
This shortfall is sizable relative to its market capitalization of US$507.8 million, so he suggests shareholders watch DorianG’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
We measure a company’s leverage against 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 charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
DorianG has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 5.4 times. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. Unfortunately, DorianG’s EBIT has fallen 15% over the past four quarters. If that kind of decline isn’t stopped, then managing his debt will be harder than selling broccoli flavored ice cream for a premium. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine DorianG’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Fortunately for all shareholders, DorianG has actually produced more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
Neither DorianG’s ability to increase its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is that it seems to be able to easily convert EBIT to free cash flow. Considering the above factors, we believe that DorianG’s debt poses certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. 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 outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for DorianG (1 of which makes us a little uncomfortable!) that you should know.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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