Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Navigator Holdings Ltd. (NYSE:NVGS) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Navigator Holdings Carry?
As you can see below, at the end of June 2019, Navigator Holdings had US$856.5m of debt, up from US$823.1m a year ago. Click the image for more detail. However, because it has a cash reserve of US$47.3m, its net debt is less, at about US$809.2m.
A Look At Navigator Holdings's Liabilities
We can see from the most recent balance sheet that Navigator Holdings had liabilities of US$107.0m falling due within a year, and liabilities of US$795.3m due beyond that. Offsetting these obligations, it had cash of US$47.3m as well as receivables valued at US$22.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$833.0m.
This deficit casts a shadow over the US$519.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Navigator Holdings would likely require a major re-capitalisation if it had to pay its creditors today.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Weak interest cover of 0.67 times and a disturbingly high net debt to EBITDA ratio of 7.9 hit our confidence in Navigator Holdings like a one-two punch to the gut. The debt burden here is substantial. Even more troubling is the fact that Navigator Holdings actually let its EBIT decrease by 9.3% over the last year. If that earnings trend continues the company will face an uphill battle to pay off its debt. 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 Navigator 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Navigator Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
To be frank both Navigator Holdings's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its net debt to EBITDA fails to inspire much confidence. We think the chances that Navigator Holdings has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. While Navigator Holdings didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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