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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. As with many other companies Eastman Kodak Company (NYSE:KODK) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Eastman Kodak's Debt?
The image below, which you can click on for greater detail, shows that Eastman Kodak had debt of US$15.0m at the end of September 2020, a reduction from US$104.0m over a year. But on the other hand it also has US$193.0m in cash, leading to a US$178.0m net cash position.
A Look At Eastman Kodak's Liabilities
Zooming in on the latest balance sheet data, we can see that Eastman Kodak had liabilities of US$295.0m due within 12 months and liabilities of US$648.0m due beyond that. Offsetting these obligations, it had cash of US$193.0m as well as receivables valued at US$155.0m due within 12 months. So its liabilities total US$595.0m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of US$648.2m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Eastman Kodak boasts net cash, so it's fair to say it does not have a heavy debt load!
Importantly, Eastman Kodak's EBIT fell a jaw-dropping 41% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Eastman Kodak will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Eastman Kodak 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, Eastman Kodak 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.
While Eastman Kodak does have more liabilities than liquid assets, it also has net cash of US$178.0m. Unfortunately, though, both its struggle EBIT growth rate and its conversion of EBIT to free cash flow leave us concerned about Eastman Kodak So even though it has net cash, we do think the business has some risks worth watching. 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 3 warning signs for Eastman Kodak (2 are significant!) that you should be aware of before investing here.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
This article by Simply Wall St is general in nature. 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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