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. Importantly, Kronos Worldwide, Inc. (NYSE:KRO) does carry debt. But is this debt a concern to shareholders?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Kronos Worldwide's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Kronos Worldwide had US$447.3m of debt in March 2019, down from US$488.1m, one year before. However, it also had US$339.5m in cash, and so its net debt is US$107.8m.
A Look At Kronos Worldwide's Liabilities
Zooming in on the latest balance sheet data, we can see that Kronos Worldwide had liabilities of US$241.3m due within 12 months and liabilities of US$834.5m due beyond that. Offsetting this, it had US$339.5m in cash and US$354.0m in receivables that were due within 12 months. So its liabilities total US$382.3m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Kronos Worldwide has a market capitalization of US$1.38b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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.
Kronos Worldwide has a low net debt to EBITDA ratio of only 0.37. And its EBIT easily covers its interest expense, being 18.7 times the size. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Kronos Worldwide's load is not too heavy, because its EBIT was down 39% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Kronos Worldwide's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
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, Kronos Worldwide produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Kronos Worldwide's EBIT growth rate and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that Kronos Worldwide is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Given our hesitation about the stock, it would be good to know if Kronos Worldwide insiders have sold any shares recently. You click here to find out if insiders have sold recently.
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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