Is Canfor (TSE:CFP) A Risky Investment?
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.' 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 Canfor Corporation (TSE:CFP) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Canfor
What Is Canfor's Debt?
The chart below, which you can click on for greater detail, shows that Canfor had CA$265.8m in debt in June 2022; about the same as the year before. However, its balance sheet shows it holds CA$1.53b in cash, so it actually has CA$1.27b net cash.
A Look At Canfor's Liabilities
We can see from the most recent balance sheet that Canfor had liabilities of CA$1.08b falling due within a year, and liabilities of CA$1.08b due beyond that. Offsetting these obligations, it had cash of CA$1.53b as well as receivables valued at CA$618.6m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
Having regard to Canfor's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CA$3.31b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Canfor also has more cash than debt, so we're pretty confident it can manage its debt safely.
In fact Canfor's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Canfor 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Canfor may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last two years, Canfor produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
We could understand if investors are concerned about Canfor's liabilities, but we can be reassured by the fact it has has net cash of CA$1.27b. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in CA$999m. So we are not troubled with Canfor's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Canfor (1 is potentially serious!) that you should be aware of before investing here.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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