Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that FleetCor Technologies, Inc. (NYSE:FLT) does use debt in its business. But the more important question is: how much risk is that debt creating?
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 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is FleetCor Technologies's Net Debt?
As you can see below, FleetCor Technologies had US$4.61b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have US$1.17b in cash offsetting this, leading to net debt of about US$3.44b.
How Strong Is FleetCor Technologies's Balance Sheet?
We can see from the most recent balance sheet that FleetCor Technologies had liabilities of US$4.75b falling due within a year, and liabilities of US$3.38b due beyond that. On the other hand, it had cash of US$1.17b and US$2.70b worth of receivables due within a year. So it has liabilities totalling US$4.26b more than its cash and near-term receivables, combined.
Given FleetCor Technologies has a humongous market capitalization of US$25.9b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
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.
FleetCor Technologies's net debt of 2.4 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.7 times its interest expenses harmonizes with that theme. If FleetCor Technologies can keep growing EBIT at last year's rate of 18% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if FleetCor Technologies can strengthen its balance sheet over time. 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 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, FleetCor Technologies generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
FleetCor Technologies's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. Zooming out, FleetCor Technologies seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. Over time, share prices tend to follow earnings per share, so if you're interested in FleetCor Technologies, you may well want to click here to check an interactive graph of its earnings per share history.
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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