Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Acushnet Holdings Corp. (NYSE:GOLF) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Acushnet Holdings's Debt?
The image below, which you can click on for greater detail, shows that Acushnet Holdings had debt of US$410.8m at the end of June 2019, a reduction from US$444.5m over a year. However, because it has a cash reserve of US$40.9m, its net debt is less, at about US$369.9m.
How Healthy Is Acushnet Holdings's Balance Sheet?
The latest balance sheet data shows that Acushnet Holdings had liabilities of US$356.1m due within a year, and liabilities of US$493.3m falling due after that. Offsetting these obligations, it had cash of US$40.9m as well as receivables valued at US$306.4m due within 12 months. So it has liabilities totalling US$502.1m more than its cash and near-term receivables, combined.
Acushnet Holdings has a market capitalization of US$2.12b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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.
With a debt to EBITDA ratio of 2.0, Acushnet Holdings uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 8.3 times its interest expenses harmonizes with that theme. Sadly, Acushnet Holdings's EBIT actually dropped 8.3% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Acushnet Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Acushnet Holdings recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Neither Acushnet Holdings's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But it seems to be able to cover its interest expense with its EBIT without much trouble. Looking at all the angles mentioned above, it does seem to us that Acushnet Holdings is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Acushnet Holdings's earnings per share history for free.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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