Howard Marks put it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Above all, Frontier Transport Holdings Limited (JSE: FTH) is in debt. But does this debt worry shareholders?
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies 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 flow and debt together.
Check out our latest review for Frontier Transport Holdings
What is Frontier Transport Holdings’ net debt?
You can click on the graph below for the historical figures, but it shows that Frontier Transport Holdings had a debt of Rand 284.5million in September 2021, up from Rand 451.6million a year earlier. However, his balance sheet shows that he holds R468.6 million in cash, so he actually has net cash of R184.1 million.
How healthy is Frontier Transport Holdings’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Frontier Transport Holdings had liabilities of Rand 463.7 million due within 12 months and liabilities of Rand 525.4 million due beyond. In compensation for these obligations, he had cash of R 468.6 million as well as receivables valued at R 146.0 million maturing within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by Rand 374.5 million.
While that might sound like a lot, it’s not so bad since Frontier Transport Holdings has a market cap of R1.55b, and could therefore likely strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at one’s ability to repay debts. Despite its notable liabilities, Frontier Transport Holdings has a net cash flow, so it’s fair to say that it doesn’t have a lot of debt!
Another good thing is that Frontier Transport Holdings has increased its EBIT to 10% over the past year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in isolation; since Frontier Transport Holdings will need revenue to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. Frontier Transport Holdings may have net cash on the balance sheet, but it’s always interesting to consider the extent to which the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Fortunately for all shareholders, Frontier Transport Holdings has actually generated more free cash flow than EBIT over the past three years. This kind of cash conversion makes us as excited as the crowd when the pace drops at a Daft Punk concert.
Although Frontier Transport Holdings has more liabilities than liquid assets, it also has net cash of Rand 184.1 million. And he impressed us with free cash flow of Rand 374 million, or 110% of his EBIT. So is Frontier Transport Holdings’ debt a risk? It does not seem to us. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Be aware that Frontier Transport Holdings displays 4 warning signs in our investment analysis , and 1 of them is potentially serious …
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.