Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Briggs & Stratton Corporation (NYSE:BGG) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Briggs & Stratton Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Briggs & Stratton had debt of US$413.8m, up from US$333.9m in one year. However, it also had US$23.9m in cash, and so its net debt is US$389.9m.
How Healthy Is Briggs & Stratton's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Briggs & Stratton had liabilities of US$627.1m due within 12 months and liabilities of US$481.4m due beyond that. Offsetting these obligations, it had cash of US$23.9m as well as receivables valued at US$253.5m due within 12 months. So it has liabilities totalling US$831.1m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the US$365.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Briggs & Stratton would probably need a major re-capitalization if its creditors were to demand repayment.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While we wouldn't worry about Briggs & Stratton's net debt to EBITDA ratio of 4.0, we think its super-low interest cover of 1.4 times is a sign of high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, Briggs & Stratton saw its EBIT tank 55% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Briggs & Stratton's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Briggs & Stratton burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
On the face of it, Briggs & Stratton's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. It looks to us like Briggs & Stratton carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. Given our concerns about Briggs & Stratton's debt levels, it seems only prudent to check if insiders have been ditching the stock.
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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