We think Brambles (ASX:BXB) can stay on top of its debt


Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Brambles Limited (ASX:BXB) has debt on its balance sheet. But the more important question is: what risk does this debt create?

What risk does debt carry?

Debt helps a business until the business struggles to pay it back, 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 painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. 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. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

See our latest analysis for brambles

What is Brambles’ net debt?

The chart below, which you can click on for more details, shows that Brambles had $1.98 billion in debt as of December 2021; about the same as the previous year. However, since it has a cash reserve of $194.0 million, its net debt is less, at around $1.79 billion.

ASX: BXB Debt to Equity February 28, 2022

A look at Brambles’ responsibilities

Zooming in on the latest balance sheet data, we can see that Brambles had liabilities of US$2.02 billion due within 12 months and liabilities of US$3.03 billion due beyond. In return, it had $194.0 million in cash and $912.2 million in receivables due within 12 months. Thus, its liabilities total $3.94 billion more than the combination of its cash and short-term receivables.

This shortfall is not that bad as Brambles is worth US$10.1 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.

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). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Brambles has a low net debt to EBITDA ratio of just 1.1. And its EBIT covers its interest charges 14.7 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Another good thing is that Brambles has increased its EBIT by 15% over the past year, further increasing its ability to manage debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Brambles’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a company can only repay its debts with cash, not book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Brambles has recorded free cash flow of 27% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.

Our point of view

Based on our analysis, Brambles’ interest coverage should signal that it won’t have too many problems with its debt. But the other factors we noted above weren’t so encouraging. For example, its EBIT to free cash flow conversion makes us a bit nervous about its debt. Given this range of data points, we believe Brambles is in a good position to manage its level of leverage. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. 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. Example: we have identified 3 warning signs for brambles you should be aware.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.


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