David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ 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. We can see that Norfolk Southern Corporation (NYSE: NSC) uses debt in its business. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
How much debt does Norfolk Southern have?
As you can see below, at the end of September 2021, Norfolk Southern had $ 14.4 billion in debt, down from $ 13.0 billion a year ago. Click on the image for more details. However, he also had $ 1.47 billion in cash, so his net debt is $ 12.9 billion.
NYSE Debt to Equity History: NSC January 3, 2022
How healthy is Norfolk Southern’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Norfolk Southern had a liability of US $ 2.41 billion due within 12 months and a liability of US $ 22.3 billion beyond. In return, he had $ 1.47 billion in cash and $ 945.0 million in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 22.3 billion.
While that might sound like a lot, it’s not that big of a deal since Norfolk Southern has a massive market cap of US $ 72.4 billion, so it could 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.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we look at debt versus earnings with and without amortization expenses.
Norfolk Southern has net debt worth 2.3 times EBITDA, which isn’t too much, but its interest coverage looks a bit weak, with EBIT at just 6.9 times interest expense. While this doesn’t worry us too much, it does suggest that the interest payments are somewhat of a burden. It is also important to note that Norfolk Southern increased its EBIT by a very respectable 28% last year, improving its ability to repay its debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Norfolk Southern’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals are thinking, you might find this free report on analysts’ earnings forecasts Be interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Over the past three years, Norfolk Southern has generated strong free cash flow equivalent to 54% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
Norfolk Southern’s EBIT growth rate suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And its interest coverage is good too. Looking at all of the above factors together, it seems to us that Norfolk Southern can manage its debt quite comfortably. Of course, while this leverage can improve returns on equity, it comes with more risk, so it’s worth keeping an eye out for. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 1 warning sign for Norfolk Southern you must be aware.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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