Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, AGCO Corporation (NYSE:AGCO) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is AGCO's Net Debt?
The image below, which you can click on for greater detail, shows that AGCO had debt of US$1.80b at the end of June 2019, a reduction from US$1.95b over a year. However, it also had US$279.9m in cash, and so its net debt is US$1.52b.
A Look At AGCO's Liabilities
Zooming in on the latest balance sheet data, we can see that AGCO had liabilities of US$3.23b due within 12 months and liabilities of US$2.06b due beyond that. Offsetting this, it had US$279.9m in cash and US$1.01b in receivables that were due within 12 months. So its liabilities total US$4.00b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$5.62b, so it does suggest shareholders should keep an eye on AGCO's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
AGCO's net debt to EBITDA ratio of about 1.8 suggests only moderate use of debt. And its commanding EBIT of 77.3 times its interest expense, implies the debt load is as light as a peacock feather. If AGCO can keep growing EBIT at last year's rate of 19% over the last year, then it will find its debt load easier to manage. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if AGCO can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, AGCO recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
When it comes to the balance sheet, the standout positive for AGCO was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its level of total liabilities makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that AGCO is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. We'd be motivated to research the stock further if we found out that AGCO insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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