Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Commercial Vehicle Group, Inc. (NASDAQ:CVGI) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Commercial Vehicle Group's Debt?
The chart below, which you can click on for greater detail, shows that Commercial Vehicle Group had US$159.0m in debt in June 2019; about the same as the year before. On the flip side, it has US$60.5m in cash leading to net debt of about US$98.5m.
A Look At Commercial Vehicle Group's Liabilities
According to the last reported balance sheet, Commercial Vehicle Group had liabilities of US$136.3m due within 12 months, and liabilities of US$187.5m due beyond 12 months. On the other hand, it had cash of US$60.5m and US$157.9m worth of receivables due within a year. So it has liabilities totalling US$105.4m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Commercial Vehicle Group is worth US$232.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While Commercial Vehicle Group's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.5 last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. If Commercial Vehicle Group can keep growing EBIT at last year's rate of 16% over the last year, then it will find its debt load easier to manage. 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 Commercial Vehicle Group's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Commercial Vehicle Group created free cash flow amounting to 11% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
While Commercial Vehicle Group's conversion of EBIT to free cash flow does give us pause, its EBIT growth rate and net debt to EBITDA suggest it can stay on top of its debt load. We think that Commercial Vehicle Group's debt does make it a bit risky, after considering the aforementioned data points together. 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 Commercial Vehicle Group's earnings per share history for free.
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.
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