Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Tsakos Energy Navigation Limited (NYSE:TNP) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Tsakos Energy Navigation's Debt?
As you can see below, Tsakos Energy Navigation had US$1.57b of debt at March 2019, down from US$1.71b a year prior. However, it does have US$177.3m in cash offsetting this, leading to net debt of about US$1.39b.
How Strong Is Tsakos Energy Navigation's Balance Sheet?
The latest balance sheet data shows that Tsakos Energy Navigation had liabilities of US$271.2m due within a year, and liabilities of US$1.42b falling due after that. Offsetting these obligations, it had cash of US$177.3m as well as receivables valued at US$57.6m due within 12 months. So it has liabilities totalling US$1.46b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the US$244.4m 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, Tsakos Energy Navigation 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Tsakos Energy Navigation shareholders face the double whammy of a high net debt to EBITDA ratio (7.1), and fairly weak interest coverage, since EBIT is just 0.80 times the interest expense. This means we'd consider it to have a heavy debt load. However, one redeeming factor is that Tsakos Energy Navigation grew its EBIT at 16% over the last 12 months, boosting its ability to handle its debt. 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 Tsakos Energy Navigation can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Tsakos Energy Navigation burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
To be frank both Tsakos Energy Navigation'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. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Taking into account all the aforementioned factors, it looks like Tsakos Energy Navigation has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Even though Tsakos Energy Navigation 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.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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