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. 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 note that Navios Maritime Acquisition Corporation (NYSE:NNA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Navios Maritime Acquisition's Debt?
The image below, which you can click on for greater detail, shows that at September 2019 Navios Maritime Acquisition had debt of US$1.16b, up from US$1.02b in one year. However, it does have US$102.9m in cash offsetting this, leading to net debt of about US$1.05b.
How Strong Is Navios Maritime Acquisition's Balance Sheet?
We can see from the most recent balance sheet that Navios Maritime Acquisition had liabilities of US$50.8m falling due within a year, and liabilities of US$1.23b due beyond that. On the other hand, it had cash of US$102.9m and US$61.8m worth of receivables due within a year. So its liabilities total US$1.11b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$107.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Navios Maritime Acquisition 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Navios Maritime Acquisition shareholders face the double whammy of a high net debt to EBITDA ratio (11.3), and fairly weak interest coverage, since EBIT is just 0.73 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for Navios Maritime Acquisition is that it turned last year's EBIT loss into a gain of US$59m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Navios Maritime Acquisition 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. In the last year, Navios Maritime Acquisition created free cash flow amounting to 10% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
On the face of it, Navios Maritime Acquisition's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. After considering the datapoints discussed, we think Navios Maritime Acquisition has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Even though Navios Maritime Acquisition lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending over the last few years.
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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