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. Importantly, Griffin Industrial Realty, Inc. (NASDAQ:GRIF) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Griffin Industrial Realty's Net Debt?
The image below, which you can click on for greater detail, shows that at May 2019 Griffin Industrial Realty had debt of US$145.8m, up from US$134.1m in one year. However, because it has a cash reserve of US$6.98m, its net debt is less, at about US$138.9m.
A Look At Griffin Industrial Realty's Liabilities
We can see from the most recent balance sheet that Griffin Industrial Realty had liabilities of US$5.33m falling due within a year, and liabilities of US$162.1m due beyond that. Offsetting this, it had US$6.98m in cash and US$6.57m in receivables that were due within 12 months. So it has liabilities totalling US$153.9m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$190.5m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Weak interest cover of 2.0 times and a disturbingly high net debt to EBITDA ratio of 6.1 hit our confidence in Griffin Industrial Realty like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. The good news is that Griffin Industrial Realty grew its EBIT a smooth 77% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 Griffin Industrial Realty will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Griffin Industrial Realty produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Griffin Industrial Realty's net debt to EBITDA was a real negative on this analysis, as was its interest cover. But its EBIT growth rate was significantly redeeming. When we consider all the factors mentioned above, we do feel a bit cautious about Griffin Industrial Realty's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. Over time, share prices tend to follow earnings per share, so if you're interested in Griffin Industrial Realty, you may well want to click here to check an interactive graph of its earnings per share history.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.