We believe Axalta Coating Systems (NYSE: AXTA) is taking risks with its debt
Warren Buffett said: “Volatility is far from synonymous with risk”. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We notice that Axalta Coating Systems Ltée. (NYSE: AXTA) has debt on its balance sheet. But the most important question is: what risk does this debt create?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest review for Axalta Coating Systems
What is Axalta Coating Systems’ debt?
As you can see below, at the end of March 2021, Axalta Coating Systems was in debt of $ 3.74 billion, up from $ 3.59 billion a year ago. Click on the image for more details. However, he also had $ 1.27 billion in cash, so his net debt is $ 2.48 billion.
A look at the responsibilities of Axalta Coating Systems
We can see from the most recent balance sheet that Axalta Coating Systems had liabilities of US $ 1.19 billion due within one year and liabilities of US $ 4.42 billion due beyond. . On the other hand, it had US $ 1.27 billion in cash and US $ 940.4 million in receivables due within a year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 3.41 billion.
While that might sound like a lot, it’s not that bad as Axalta Coating Systems has a market capitalization of US $ 7.07 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
While Axalta Coating Systems’ debt to EBITDA ratio (3.5) suggests that it is using some debt, its interest coverage is very low at 2.5, suggesting high leverage. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. Worse, Axalta Coating Systems’ EBIT fell by 30% compared to last year. If profits continue to follow this path, it will be more difficult to pay off this debt than to convince us to run a marathon in the rain. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Axalta Coating Systems can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Axalta Coating Systems has recorded free cash flow totaling 88% of its EBIT, which is higher than what we normally expected. This positions it well to repay debt if it is desirable.
Our point of view
Neither Axalta Coating Systems’ ability to increase its EBIT nor its interest coverage gave us confidence in its ability to take on more debt. But the good news is that it seems to be able to easily convert EBIT into free cash flow. Taking the above factors together, we believe Axalta Coating Systems’ debt presents certain risks to the business. So while this leverage increases ROE, we wouldn’t really want to see it increase from here. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 3 warning signs for Axalta Coating Systems (1 is concerning!) Which you should know before investing here.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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