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 seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Canadian Tire Corporation Limited (TSE:CTC.A) is in debt. But does this debt worry shareholders?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. 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. Of course, many companies use debt to finance their 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 Canadian Tire Corporation
How much debt does Canadian Tire Corporation have?
As you can see below, Canadian Tire Corporation had C$7.65 billion in debt in July 2022, up from C$8.51 billion the previous year. However, it has C$724.6 million in cash to offset this, resulting in a net debt of approximately C$6.93 billion.
A Look at Canadian Tire Corporation’s Liabilities
According to the last published balance sheet, Canadian Tire Corporation had liabilities of C$6.08 billion due within 12 months and liabilities of C$8.37 billion due beyond 12 months. In compensation for these obligations, it had cash of 724.6 million Canadian dollars as well as receivables valued at 857.8 million Canadian dollars maturing within 12 months. It therefore has liabilities totaling C$12.9 billion more than its cash and short-term receivables, combined.
When you consider that this shortfall exceeds the company’s C$10.4 billion market capitalization, you might well be inclined to take a close look at the balance sheet. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). 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 ).
Canadian Tire Corporation has a net debt to EBITDA ratio of 3.1, suggesting it is using good leverage to increase returns. But the high interest coverage of 8.7 suggests it can easily repay that debt. Unfortunately, Canadian Tire Corporation has seen its EBIT drop by 5.0% over the past twelve months. If earnings continue to fall, managing that debt will be as difficult as delivering hot soup on a unicycle. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Canadian Tire Corporation can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Canadian Tire Corporation has generated strong free cash flow equivalent to 65% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Reflecting on Canadian Tire Corporation’s attempt to control its total liabilities, we are certainly not enthusiastic. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Once we consider all of the above factors together, it seems to us that Canadian Tire Corporation’s debt makes it a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on less debt. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Canadian Tire Corporation (1 of which makes us a little uncomfortable!) that you should know.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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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.
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