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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Port of Tauranga Limited (NZSE:POT) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Port of Tauranga
What Is Port of Tauranga's Debt?
The image below, which you can click on for greater detail, shows that at December 2018 Port of Tauranga had debt of NZ$469.1m, up from NZ$431.0m in one year. Net debt is about the same, since the it doesn't have much cash.
How Healthy Is Port of Tauranga's Balance Sheet?
According to the last reported balance sheet, Port of Tauranga had liabilities of NZ$321.5m due within 12 months, and liabilities of NZ$259.8m due beyond 12 months. On the other hand, it had cash of NZ$3.19m and NZ$58.0m worth of receivables due within a year. So it has liabilities totalling NZ$520.1m more than its cash and near-term receivables, combined.
Of course, Port of Tauranga has a market capitalization of NZ$4.09b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).