David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ 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 Covenant Logistics Group, Inc. (NASDAQ:CVLG) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
View our latest analysis for Covenant Logistics Group
What Is Covenant Logistics Group’s Debt?
The image below, which you can click on for greater detail, shows that Covenant Logistics Group had debt of US$30.4m at the end of September 2021, a reduction from US$104.4m over a year. However, because it has a cash reserve of US$22.2m, its net debt is less, at about US$8.22m.
A Look At Covenant Logistics Group’s Liabilities
We can see from the most recent balance sheet that Covenant Logistics Group had liabilities of US$207.7m falling due within a year, and liabilities of US$166.4m due beyond that. Offsetting this, it had US$22.2m in cash and US$138.7m in receivables that were due within 12 months. So it has liabilities totalling US$213.2m more than its cash and near-term receivables, combined.
Covenant Logistics Group has a market capitalization of US$460.1m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Covenant Logistics Group has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.075 and EBIT of 17.5 times the interest expense. So relative to past earnings, the debt load seems trivial. It was also good to see that despite losing money on the EBIT line last year, Covenant Logistics Group turned things around in the last 12 months, delivering and EBIT of US$54m. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Covenant Logistics Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it’s worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Covenant Logistics Group generated free cash flow amounting to a very robust 100% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
Our View
Covenant Logistics Group’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. Taking all this data into account, it seems to us that Covenant Logistics Group takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we’ve discovered 1 warning sign for Covenant Logistics Group that you should be aware of before investing here.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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