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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We note that TravelCenters of America Inc. (NASDAQ:TA) does have debt on its balance sheet. But is this debt a concern to shareholders?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
What Is TravelCenters of America's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2021 TravelCenters of America had US$524.9m of debt, an increase on US$338.0m, over one year. However, its balance sheet shows it holds US$621.1m in cash, so it actually has US$96.2m net cash.
How Healthy Is TravelCenters of America's Balance Sheet?
According to the last reported balance sheet, TravelCenters of America had liabilities of US$573.3m due within 12 months, and liabilities of US$2.31b due beyond 12 months. Offsetting this, it had US$621.1m in cash and US$149.4m in receivables that were due within 12 months. So it has liabilities totalling US$2.12b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the US$865.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, TravelCenters of America would likely require a major re-capitalisation if it had to pay its creditors today. Given that TravelCenters of America has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.
One way TravelCenters of America could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 13%, as it did over the last year. 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 TravelCenters of America 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While TravelCenters of America has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, TravelCenters of America burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While TravelCenters of America does have more liabilities than liquid assets, it also has net cash of US$96.2m. And it also grew its EBIT by 13% over the last year. Despite its cash we think that TravelCenters of America seems to struggle to handle its total liabilities, so we are wary of the stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for TravelCenters of America you should be aware of, and 2 of them can't be ignored.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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