Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Cooper-Standard Holdings Inc. (NYSE:CPS) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Cooper-Standard Holdings Carry?
The chart below, which you can click on for greater detail, shows that Cooper-Standard Holdings had US$772.5m in debt in June 2019; about the same as the year before. However, it does have US$310.8m in cash offsetting this, leading to net debt of about US$461.7m.
How Healthy Is Cooper-Standard Holdings's Balance Sheet?
According to the last reported balance sheet, Cooper-Standard Holdings had liabilities of US$708.7m due within 12 months, and liabilities of US$1.04b due beyond 12 months. Offsetting these obligations, it had cash of US$310.8m as well as receivables valued at US$635.7m due within 12 months. So its liabilities total US$799.2m more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of US$704.1m, we think shareholders really should watch Cooper-Standard Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While Cooper-Standard Holdings has a quite reasonable net debt to EBITDA multiple of 1.8, its interest cover seems weak, at 2.5. The main reason for this is that it has such high depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason -- some assets are seen to be losing value. Either way there's no doubt the stock is using meaningful leverage. Importantly, Cooper-Standard Holdings's EBIT fell a jaw-dropping 65% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Cooper-Standard Holdings's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Cooper-Standard Holdings created free cash flow amounting to 16% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
Mulling over Cooper-Standard Holdings's attempt at (not) growing its EBIT, we're certainly not enthusiastic. Having said that, its ability handle its debt, based on its EBITDA, isn't such a worry. Taking into account all the aforementioned factors, it looks like Cooper-Standard Holdings has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Given our concerns about Cooper-Standard Holdings's debt levels, it seems only prudent to check if insiders have been ditching the stock.
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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