Some say volatility, rather than debt, is the best way to view risk as an investor, but Warren Buffett said “volatility is far from 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 can see that TransUnion (NYSE: TRU) uses debt in its business. But does this debt worry shareholders?
When Is Debt a Problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. 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.
What is TransUnion’s debt?
As you can see below, TransUnion had US $ 3.40 billion in debt in June 2021, up from US $ 3.73 billion the year before. However, it has $ 529.4 million in cash offsetting that, leading to net debt of around $ 2.87 billion.
NYSE Debt to Equity History: TRU October 26, 2021
How healthy is TransUnion’s balance sheet?
The latest balance sheet data shows that TransUnion had liabilities of US $ 601.8 million due within one year and liabilities of US $ 3.89 billion due thereafter. On the other hand, it had US $ 529.4 million in cash and US $ 513.4 million in receivables due within one year. Its liabilities therefore total $ 3.44 billion more than the combination of its cash and short-term receivables.
Of course, TransUnion has a titanic market cap of US $ 22.6 billion, so those liabilities are likely manageable. Having said that, it is clear that we must continue to monitor his record lest it get worse.
We measure a company’s debt load relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With net debt to EBITDA of 2.6, TransUnion has some pretty significant debt. But the high interest coverage of 7.2 suggests that he can easily pay off that debt. One way for TransUnion to beat its debt would be to stop borrowing more but continue to increase its EBIT by about 15%, as it did last year. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether TransUnion can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, TransUnion 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
Fortunately, TransUnion’s impressive conversion of EBIT to free cash flow means it has the upper hand over its debt. But frankly, we think its net debt to EBITDA undermines that impression a bit. Given all of this data, it seems to us that TransUnion is taking a fairly smart approach to debt. This means that they are taking a bit more risk, in the hope of increasing returns for shareholders. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. Example: we have spotted 1 warning sign for TransUnion you must be aware.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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