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. As with many other companies Chorus Aviation Inc. (TSE:CHR) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Chorus Aviation Carry?
As you can see below, at the end of June 2019, Chorus Aviation had CA$1.54b of debt, up from CA$1.35b a year ago. Click the image for more detail. On the flip side, it has CA$127.6m in cash leading to net debt of about CA$1.41b.
A Look At Chorus Aviation's Liabilities
We can see from the most recent balance sheet that Chorus Aviation had liabilities of CA$379.6m falling due within a year, and liabilities of CA$1.66b due beyond that. Offsetting this, it had CA$127.6m in cash and CA$97.3m in receivables that were due within 12 months. So its liabilities total CA$1.81b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the CA$1.20b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, Chorus Aviation 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Chorus Aviation has a debt to EBITDA ratio of 4.1 and its EBIT covered its interest expense 3.4 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Chorus Aviation improved its EBIT by 3.0% over the last twelve years, thus gradually reducing its debt levels relative to its earnings. 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 Chorus Aviation 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Chorus Aviation burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
On the face of it, Chorus Aviation's level of total liabilities left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. After considering the datapoints discussed, we think Chorus Aviation has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Given our concerns about Chorus Aviation's debt levels, it seems only prudent to check if insiders have been ditching the stock.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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