Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Clean Harbors, Inc. (NYSE:CLH) does carry debt. But the real question is whether this debt is making the company risky.
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Clean Harbors Carry?
The image below, which you can click on for greater detail, shows that at June 2024 Clean Harbors had debt of US$2.79b, up from US$2.30b in one year. However, it also had US$493.3m in cash, and so its net debt is US$2.30b.
A Look At Clean Harbors' Liabilities
We can see from the most recent balance sheet that Clean Harbors had liabilities of US$1.06b falling due within a year, and liabilities of US$3.63b due beyond that. Offsetting this, it had US$493.3m in cash and US$1.28b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.92b.
Clean Harbors has a very large market capitalization of US$12.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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.
Clean Harbors has net debt worth 2.2 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.2 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly Clean Harbors's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. 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 Clean Harbors can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Clean Harbors recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Our View
Clean Harbors's conversion of EBIT to free cash flow was a real negative on this analysis, as was its net debt to EBITDA. On the other hand, we found comfort in its relatively strong level of total liabilities. Looking at all this data makes us feel a little cautious about Clean Harbors's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Clean Harbors is showing 2 warning signs in our investment analysis , you should know about...
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
