Yahoo Finance Tassal Group (ASX:TGR) Has A Somewhat Strained Balance Sheet
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Tassal Group Limited (ASX:TGR) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Tassal Group
What Is Tassal Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Tassal Group had AU$176.9m of debt, an increase on AU$133.6m, over one year. However, because it has a cash reserve of AU$24.6m, its net debt is less, at about AU$152.3m.
How Strong Is Tassal Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Tassal Group had liabilities of AU$124.4m due within 12 months and liabilities of AU$325.2m due beyond that. Offsetting these obligations, it had cash of AU$24.6m as well as receivables valued at AU$18.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$406.9m.
This deficit isn't so bad because Tassal Group is worth AU$810.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Tassal Group's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 10.1 times the size. So we're pretty relaxed about its super-conservative use of debt. The good news is that Tassal Group has increased its EBIT by 5.9% over twelve months, which should ease any concerns about debt repayment. 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 Tassal Group 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, Tassal Group actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Our View
Tassal Group's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its interest cover was re-invigorating. Taking the abovementioned factors together we do think Tassal Group's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. Given our hesitation about the stock, it would be good to know if Tassal Group insiders have sold any shares recently. You click here to find out if insiders have sold recently.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
