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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Hardwoods Distribution Inc. (TSE:HDI) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Hardwoods Distribution
How Much Debt Does Hardwoods Distribution Carry?
As you can see below, Hardwoods Distribution had CA$95.7m of debt at June 2019, down from CA$129.8m a year prior. However, because it has a cash reserve of CA$3.39m, its net debt is less, at about CA$92.3m.
How Healthy Is Hardwoods Distribution's Balance Sheet?
According to the last reported balance sheet, Hardwoods Distribution had liabilities of CA$167.1m due within 12 months, and liabilities of CA$80.7m due beyond 12 months. On the other hand, it had cash of CA$3.39m and CA$125.1m worth of receivables due within a year. So it has liabilities totalling CA$119.3m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Hardwoods Distribution has a market capitalization of CA$255.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).