David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Compass Minerals International, Inc. (NYSE:CMP) is in debt. But the real question is whether this debt makes the business risky.

When is debt a problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest analysis for Compass Minerals International

How much debt does Compass Minerals International have?

The image below, which you can click on for more details, shows that Compass Minerals International had debt of $922.2 million at the end of March 2022, a reduction from $1.18 billion year-on-year . On the other hand, he has $44.9 million in cash, resulting in a net debt of around $877.3 million.

A look at the liabilities of Compass Minerals International

The latest balance sheet data shows that Compass Minerals International had liabilities of US$224.2 million due within one year, and liabilities of US$1.14 billion falling due thereafter. In compensation for these obligations, it had cash of US$44.9 million as well as receivables valued at US$197.3 million and payable within 12 months. It therefore has liabilities totaling $1.12 billion more than its cash and short-term receivables, combined.

This is a mountain of leverage compared to its market capitalization of US$1.17 billion. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.

We measure a company’s leverage against 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 charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Low interest coverage of 0.97x and an extremely high net debt to EBITDA ratio of 5.2 shook our confidence in Compass Minerals International like a punch in the gut. The debt burden here is considerable. Worse still, Compass Minerals International has seen its EBIT drop 67% in the last 12 months. If earnings continue to follow this trajectory, paying off this debt will be more difficult than convincing 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 Compass Minerals International can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Compass Minerals International has recorded free cash flow of 75% of its EBIT, which is about normal given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.

Our point of view

At first glance, Compass Minerals International’s interest coverage left us hesitant about the stock, and its EBIT growth rate was no more appealing than the single empty restaurant on the busiest night of the year. But on the bright side, its EBIT to free cash flow conversion is a good sign and makes us more optimistic. Overall, it seems to us that the balance sheet of Compass Minerals International is very much a risk for the company. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we found 3 warning signs for Compass Minerals International (1 is concerning!) that you should be aware of before investing here.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.