Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Trinity Biotech plc (NASDAQ:TRIB) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Trinity Biotech's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Trinity Biotech had US$80.8m of debt in June 2019, down from US$95.2m, one year before. On the flip side, it has US$25.0m in cash leading to net debt of about US$55.8m.
How Healthy Is Trinity Biotech's Balance Sheet?
The latest balance sheet data shows that Trinity Biotech had liabilities of US$24.4m due within a year, and liabilities of US$108.2m falling due after that. On the other hand, it had cash of US$25.0m and US$25.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$82.1m.
The deficiency here weighs heavily on the US$20.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet." So we'd watch its balance sheet closely, without a doubt After all, Trinity Biotech would likely require a major re-capitalisation if it had to pay its creditors today.
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.
Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 7.2 hit our confidence in Trinity Biotech like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even more troubling is the fact that Trinity Biotech actually let its EBIT decrease by 2.9% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. 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 Trinity Biotech'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.
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, Trinity Biotech burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
On the face of it, Trinity Biotech's conversion of EBIT to free cash flow 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. But at least its EBIT growth rate is not so bad. It's also worth noting that Trinity Biotech is in the Medical Equipment industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think Trinity Biotech has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Even though Trinity Biotech 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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