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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. Mostly, Genco Shipping & Trading Limited (NYSE: GNK) is in debt. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. 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.
See our latest review for Genco Shipping & Trading
What is Genco Shipping & Trading’s net debt?
As you can see below, Genco Shipping & Trading had a debt of US $ 392.3 million in March 2021, up from US $ 476.7 million the year before. However, he also had $ 123.2 million in cash, so his net debt is $ 269.2 million.
How healthy is Genco Shipping & Trading’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Genco Shipping & Trading had a liability of US $ 98.9 million due within 12 months and a liability of US $ 334.7 million beyond. In return, he had $ 123.2 million in cash and $ 11.2 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 299.1 million.
Genco Shipping & Trading has a market capitalization of US $ 676.5 million, so it could most likely raise funds to improve its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
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). Thus, we consider debt versus earnings with and without amortization charges.
While we are not worried about Genco Shipping & Trading’s net debt to EBITDA ratio of 3.8, we do think its ultra-low 0.75 times interest coverage is a sign of high leverage. It appears the company incurs significant depreciation and amortization costs, so perhaps its debt load is heavier than it first appears, since EBITDA is arguably a generous measure of profits. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. However, it should be heartwarming for shareholders to remember that Genco Shipping & Trading has in fact increased its EBIT by 2.623%, over the past 12 months. If this earnings trend continues, its debt load will be much more manageable in the future. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the future profitability of the business will decide whether Genco Shipping & Trading can strengthen its balance sheet over time. So if you are focused on the future you can check out this 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. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Genco Shipping & Trading has spent a lot of money. While investors no doubt expect this situation to reverse in due course, it clearly means that its use of debt is riskier.
Our point of view
The conversion of Genco Shipping & Trading’s EBIT to free cash flow and interest coverage certainly weighs on this, in our opinion. But its EBIT growth rate tells a very different story and suggests some resilience. Taking the above factors together, we believe that Genco Shipping & Trading’s debt presents certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. The balance sheet is clearly the area you need 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 1 warning sign for Genco Shipping & Trading you should know.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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This Simply Wall St article is general in nature. 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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