Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that DHT Holdings, Inc. (NYSE:DHT) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is DHT Holdings's Net Debt?
As you can see below, DHT Holdings had US$590.7m of debt at March 2021, down from US$809.1m a year prior. However, it also had US$54.0m in cash, and so its net debt is US$536.7m.NYSE:DHT Debt to Equity History July 27th 2021
How Strong Is DHT Holdings' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that DHT Holdings had liabilities of US$38.6m due within 12 months and liabilities of US$578.4m due beyond that. On the other hand, it had cash of US$54.0m and US$29.8m worth of receivables due within a year. So its liabilities total US$533.2m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since DHT Holdings has a market capitalization of US$978.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
DHT Holdings's net debt to EBITDA ratio of about 1.5 suggests only moderate use of debt. And its strong interest cover of 10.1 times, makes us even more comfortable. Also positive, DHT Holdings grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if DHT Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, DHT Holdings recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
The good news is that DHT Holdings's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its level of total liabilities does undermine this impression a bit. All these things considered, it appears that DHT Holdings can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for DHT Holdings that you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
In This StoryDHT
- UK meat industry warns some firms have just five days' CO2 supply
- New Oriental Education & Technology Group (NYSE:EDU) stock falls 12% in past week as one-year earnings and shareholder returns continue downward trend
- This Insider Has Just Sold Shares In C3.ai, Inc. (NYSE:AI)
- Alibaba (NYSE:BABA) can Easily Afford its $15.5 billion Donation to the Common Prosperity Initiative