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 FTI Consulting, Inc. (NYSE:FCN) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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 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. 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.
How Much Debt Does FTI Consulting Carry?
The image below, which you can click on for greater detail, shows that FTI Consulting had debt of US$290.5m at the end of June 2019, a reduction from US$371.7m over a year. However, it does have US$189.1m in cash offsetting this, leading to net debt of about US$101.4m.
How Healthy Is FTI Consulting's Balance Sheet?
We can see from the most recent balance sheet that FTI Consulting had liabilities of US$463.9m falling due within a year, and liabilities of US$688.5m due beyond that. Offsetting this, it had US$189.1m in cash and US$773.0m in receivables that were due within 12 months. So it has liabilities totalling US$190.2m more than its cash and near-term receivables, combined.
Given FTI Consulting has a market capitalization of US$4.08b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
FTI Consulting's net debt is only 0.33 times its EBITDA. And its EBIT easily covers its interest expense, being 16.0 times the size. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that FTI Consulting has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if FTI Consulting 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, FTI Consulting recorded free cash flow worth 68% 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.
FTI Consulting's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think FTI Consulting is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. Another factor that would give us confidence in FTI Consulting would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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