Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Ashland Global Holdings Inc. (NYSE:ASH) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Ashland Global Holdings Carry?
The chart below, which you can click on for greater detail, shows that Ashland Global Holdings had US$2.61b in debt in June 2019; about the same as the year before. On the flip side, it has US$132.0m in cash leading to net debt of about US$2.48b.
How Healthy Is Ashland Global Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Ashland Global Holdings had liabilities of US$1.01b due within 12 months and liabilities of US$3.70b due beyond that. On the other hand, it had cash of US$132.0m and US$507.0m worth of receivables due within a year. So its liabilities total US$4.07b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$4.99b, so it does suggest shareholders should keep an eye on Ashland Global Holdings's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While Ashland Global Holdings's debt to EBITDA ratio (4.1) suggests that it uses some debt, its interest cover is very weak, at 2.4, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Fortunately, Ashland Global Holdings grew its EBIT by 6.6% in the last year, slowly shrinking its debt relative to earnings. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Ashland Global Holdings'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 report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Ashland Global Holdings produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While Ashland Global Holdings's net debt to EBITDA makes us cautious about it, its track record of covering its interest expense with its EBIT is no better. But at least its conversion of EBIT to free cash flow is a gleaming silver lining to those clouds. Taking the abovementioned factors together we do think Ashland Global Holdings's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. Over time, share prices tend to follow earnings per share, so if you're interested in Ashland Global Holdings, you may well want to click here to check an interactive graph of its earnings per share history.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.