David Iben put it well when he said, “Volatility is not a risk we care about. What we care about is preventing permanent loss of capital.’ So it may be obvious that you need to factor in debt when you consider how risky a particular stock is, as too much debt can sink a company. As with many other companies O.I Glass, Inc. (NYSE:O) takes advantage of debt. But should shareholders be concerned about using debt?
What risk does debt entail?
Debt and other obligations become risky for a company when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If the company can’t meet its legal obligations to repay debts, shareholders may end up walking away with nothing. However, a more common (but still expensive) situation is that a company has to dilute shareholders at a cheap share price in order to get its debt under control. Of course, many companies use debt to finance growth, with no negative consequences. The first thing to do when considering how much debt a company uses is to look at its cash and debt together.
How Much Debt Does OI Glass Carry?
As you can see below, OI Glass had US$5.19 billion in debt in March 2021, down from US$6.31 billion a year earlier. On the other hand, it has US$742.0 million in cash, leading to a net debt of approximately US$4.44 billion.
A Look at OI Glass’s Commitments
According to the last reported balance sheet, OI Glass had liabilities of $1.70 billion due within 12 months and liabilities of $6.86 billion due after 12 months. This was offset by US$742.0 million in cash and US$714.0 million in receivables due within 12 months. So his liabilities total US$7.11 billion more than the combination of his cash and receivables.
The deficit weighs heavily on the $3.02 billion company itself, as if a child is struggling under the weight of a huge backpack full of books, his sports equipment and a trumpet. So we definitely think shareholders should keep a close eye on this. Ultimately, OI Glass would likely need a major recapitalization if its creditors demanded repayment.
We use two main ratios to inform us of debt levels relative to income. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times earnings before interest and tax (EBIT) will cover interest costs (or interest coverage for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with the interest coverage ratio).
Weak interest coverage of 2.1 times and an alarmingly high net debt-to-EBITDA ratio of 5.3 hit our confidence in OI Glass like a one-two punch. This means we consider it highly indebted. Even worse, OI Glass saw its EBIT tank 24% over the past 12 months. If long-term earnings continue to rise like this, there’s a snowball opportunity in hell to pay off that debt. When analyzing debt levels, the balance sheet is the obvious place to start. But it is primarily future earnings that will determine OI Glass’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future, check this out free Analyst earnings forecast report.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t do it. So the logical step is to look at the portion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, OI Glass posted free cash flow of 44% of its EBIT, which is weaker than we expected. That weak cash conversion makes it harder to deal with debt.
At first glance, OI Glass’s EBIT growth left us hesitant about inventory, and the level of total liabilities was no more attractive than that one empty restaurant on the busiest night of the year. That said, the ability to convert EBIT to free cash flow isn’t much of a concern. Taking all of the above factors into account, it seems that OI Glass has too much debt. That kind of risk is okay for some, but it certainly doesn’t keep our boat afloat. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks reside within the balance sheet – far from it. To do this, you need to learn more about the 3 warning signs we spotted with OI Glass (one of which makes us a bit uncomfortable) .
Are you more interested in a fast-growing company with a strong balance sheet, then take a look our list of net cash growth stocks without delay.
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