Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies Ashland Global Holdings Inc. (NYSE: ASH) uses debt. But the most important question is: what risk does this debt create?

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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.

Check out our latest analysis for Ashland Global Holdings

What is the debt of Ashland Global Holdings?

The image below, which you can click for more details, shows Ashland Global Holdings owed $ 1.66 billion in debt at the end of March 2021, a reduction from $ 2.01 billion. of US dollars over one year. However, it has US $ 373.0 million in cash offsetting this, which leads to net debt of around US $ 1.29 billion.

How strong is Ashland Global Holdings’ balance sheet?

Zooming in on the latest balance sheet data, we can see that Ashland Global Holdings had liabilities of US $ 569.0 million due within 12 months and liabilities of US $ 2.98 billion due beyond. In return, he had $ 373.0 million in cash and $ 430.0 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 2.75 billion.

While that may sound like a lot, it’s not so bad since Ashland Global Holdings has a market capitalization of US $ 5.33 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.

We measure a company’s debt load relative to its earning capacity 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). This way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Ashland Global Holdings’ debt is 2.7 times its EBITDA, and its EBIT covers its interest expense 4.0 times. This suggests that while debt levels are significant, we would stop calling them problematic. Looking on the bright side, Ashland Global Holdings has grown its EBIT silky 53% over the past year. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of handling debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Ashland Global Holdings 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. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Ashland Global Holdings has recorded free cash flow of 75% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This hard cash allows him to reduce his debt whenever he wants.

Our point of view

Fortunately, Ashland Global Holdings’ impressive EBIT growth rate means it has the upper hand over its debt. But frankly, we think his interest in the blanket undermines that impression a bit. Looking at all of the above factors together, it seems to us that Ashland Global Holdings can manage its debt quite comfortably. On the plus side, this leverage can increase returns to shareholders, but the potential downside is more risk of loss, so it’s worth watching the balance sheet. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. To do this, you need to know the 2 warning signs we spotted with Ashland Global Holdings.

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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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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