David Iben put it well when he said: “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We note that Matson, Inc. (NYSE: MATX) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
What risk does debt entail?
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. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution of a business with the ability to reinvest at high rates of return. When we look at debt levels, we first look at cash and debt levels, together.
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What is Matson’s debt?
The image below, which you can click for more details, shows Matson owed $ 632.5 million in debt at the end of September 2021, a reduction from $ 807.9 million. over a year. On the other hand, it has $ 75.9 million in cash, resulting in net debt of around $ 556.6 million.
A look at Matson’s responsibilities
The latest balance sheet data shows that Matson had liabilities of US $ 547.3 million due within one year, and liabilities of US $ 1.33 billion due after that. In return, he had $ 75.9 million in cash and $ 328.6 million in receivables due within 12 months. It therefore has liabilities totaling US $ 1.47 billion more than its cash and short-term receivables combined.
This deficit is not that big of a deal as Matson is worth $ 3.64 billion US, and therefore could possibly raise enough capital to consolidate his balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Matson’s net debt is only 0.60 times its EBITDA. And its EBIT easily covers its interest costs, being 34.7 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Best of all, Matson increased its EBIT by 352% last year, which is an impressive improvement. This boost will make it even easier to pay down debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Matson can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Looking at the past three years, Matson has recorded free cash flow of 45% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.
Our point of view
Thankfully, Matson’s impressive interest coverage means he has the upper hand on his debt. And the good news doesn’t end there, as its EBIT growth rate also supports this impression! Considering all of this data, it seems to us that Matson is taking a pretty sane approach to debt. While this carries some risk, it can also improve returns for shareholders. 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. These risks can be difficult to spot. Every business has them, and we’ve spotted 4 warning signs for Matson (1 of which cannot be ignored!) that you should know.
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.
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 shares 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 the mentioned stocks.
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