Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a 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. Like many other companies International service company (NYSE: SCI) uses debt. But does this debt worry shareholders?
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
See our latest review for Service Corporation International
What is Service Corporation International’s debt?
As you can see below, at the end of December 2021, Service Corporation International had $3.87 billion in debt, up from $3.63 billion a year ago. Click on the image for more details. However, he also had $268.6 million in cash, so his net debt is $3.60 billion.
A look at the responsibilities of Service Corporation International
We can see from the most recent balance sheet that Service Corporation International had liabilities of US$728.3 million due within one year, and liabilities of US$13.1 billion due beyond . On the other hand, it had a cash position of 268.6 million dollars and 119.7 million dollars of receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and (current) receivables by $13.4 billion.
Given that this deficit is actually higher than the company’s massive market capitalization of $10.8 billion, we think shareholders really should be watching Service Corporation International’s debt levels, like a parent watching her child riding a bike for the first time. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
With a debt to EBITDA ratio of 2.5, Service Corporation International uses debt wisely but responsibly. And the attractive interest coverage (EBIT of 7.7 times interest expense) certainly makes do not do everything to dispel this impression. It should be noted that Service Corporation International’s EBIT has jumped like bamboo after rain, gaining 40% over the last twelve months. This will make it easier to manage your debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Service Corporation International’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Service Corporation International has produced strong free cash flow equivalent to 60% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
On the balance sheet, the most notable positive for Service Corporation International is the fact that it appears capable of growing its EBIT with confidence. However, our other observations were not so encouraging. To be precise, it seems about as good at keeping your total passive down as wet socks are at keeping your feet warm. Looking at all this data, we feel a bit cautious about Service Corporation International’s debt levels. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 2 warning signs for Service Corporation International (1 makes us a little uneasy) that you should be aware of.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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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.