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We Think Waste Connections (NYSE:WCN) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Waste Connections, Inc. (NYSE:WCN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Waste Connections

How Much Debt Does Waste Connections Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Waste Connections had US$6.90b of debt, an increase on US$5.10b, over one year. Net debt is about the same, since the it doesn't have much cash.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Waste Connections' Liabilities

The latest balance sheet data shows that Waste Connections had liabilities of US$1.51b due within a year, and liabilities of US$8.51b falling due after that. Offsetting this, it had US$96.5m in cash and US$876.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$9.05b.

While this might seem like a lot, it is not so bad since Waste Connections has a huge market capitalization of US$35.5b, 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Waste Connections has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 6.6 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. One way Waste Connections could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 18%, as it did over the last year. 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 Waste Connections 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Waste Connections generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Waste Connections's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. When we consider the range of factors above, it looks like Waste Connections is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Waste Connections you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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