These 4 measures indicate that Finning International (TSE:FTT) is using its debt reasonably well

David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Finning International Inc. (TSE:FTT) is in debt. But the real question is whether this debt makes the business risky.

What risk does debt carry?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.

See our latest analysis for Finning International

What is Finning International’s net debt?

The graph below, which you can click on for more details, shows that Finning International had C$1.53 billion in debt as of September 2021; about the same as the previous year. On the other hand, it has C$518.0 million in cash, resulting in a net debt of approximately C$1.02 billion.

How strong is Finning International’s balance sheet?

The latest balance sheet data shows that Finning International had liabilities of C$2.16 billion due within one year, and liabilities of C$1.46 billion falling due thereafter. In compensation for these obligations, it had cash of 518.0 million Canadian dollars as well as receivables valued at 1.14 billion Canadian dollars and payable within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables of C$1.95 billion.

This shortfall is not that bad as Finning International is worth C$5.46 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Finning International’s net debt of 1.5x EBITDA suggests judicious use of debt. And the attractive interest coverage (EBIT of 7.6 times interest expense) certainly makes not do everything to dispel this impression. On top of that, we are pleased to report that Finning International has increased its EBIT by 43%, reducing the specter of future debt repayments. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Finning International’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Fortunately for all shareholders, Finning International has actually produced more free cash flow than EBIT for the past three years. There’s nothing better than incoming money to stay in the good books of your lenders.

Our point of view

Fortunately, Finning International’s impressive EBIT to free cash flow conversion means it has the upper hand on its debt. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Overall, we think Finning International’s use of debt seems entirely reasonable and we are not concerned about that. After all, reasonable leverage can increase return on equity. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example – Finning International has 2 warning signs we think you should know.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.