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.