Here’s why Chemours (NYSE: CC) has a heavy debt burden
Warren Buffett said: “Volatility is far from synonymous with risk”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Mostly, The Chemours Company (NYSE: CC) is in debt. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we look at debt levels, we first consider both liquidity and debt levels.
See our latest review for Chemours
What is Chemours’ net debt?
As you can see below, Chemours was in debt of US $ 3.91 billion in March 2021, which is roughly the same as the year before. You can click on the graph for more details. On the other hand, it has $ 1.01 billion in cash, resulting in net debt of around $ 2.91 billion.
Is Chemours’ track record healthy?
Zooming in on the latest balance sheet data, we can see that Chemours had US $ 1.50 billion in liabilities due within 12 months and US $ 4.82 billion in liabilities due beyond. In compensation for these obligations, he had cash of US $ 1.01 billion as well as receivables valued at US $ 723.0 million due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 4.59 billion.
This is a mountain of leverage compared to its market cap of US $ 5.27 billion. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.
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). Thus, we consider debt versus earnings with and without amortization charges.
While we’re not worried about Chemours’ net debt to EBITDA ratio of 3.7, we do think its ultra-low 2.3x interest coverage is a sign of high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Even more troubling is the fact that Chemours actually allowed its EBIT to decline 2.7% over the past year. If this earnings trend continues, the company will face an uphill battle to repay its debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Chemours’ 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.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Chemours has generated strong free cash flow equivalent to 64% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Reflecting on Chemours’ attempt to cover its interest costs with its EBIT, we are certainly not enthusiastic. But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Looking at the balance sheet and taking all of these factors into account, we think debt makes Chemours stock a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. 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. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Chemours (1 of which is a bit unpleasant!) to know.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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