David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Great Lakes Dredge & Dock Corporation (NASDAQ:GLDD) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Great Lakes Dredge & Dock's Net Debt?
As you can see below, at the end of September 2024, Great Lakes Dredge & Dock had US$412.5m of debt, up from US$376.9m a year ago. Click the image for more detail. However, it does have US$12.0m in cash offsetting this, leading to net debt of about US$400.5m.
How Healthy Is Great Lakes Dredge & Dock's Balance Sheet?
According to the last reported balance sheet, Great Lakes Dredge & Dock had liabilities of US$177.7m due within 12 months, and liabilities of US$542.2m due beyond 12 months. On the other hand, it had cash of US$12.0m and US$126.8m worth of receivables due within a year. So its liabilities total US$581.1m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of US$781.0m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Great Lakes Dredge & Dock's debt is 3.2 times its EBITDA, and its EBIT cover its interest expense 5.3 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. We also note that Great Lakes Dredge & Dock improved its EBIT from a last year's loss to a positive US$83m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Great Lakes Dredge & Dock 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Great Lakes Dredge & Dock saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
We'd go so far as to say Great Lakes Dredge & Dock's conversion of EBIT to free cash flow was disappointing. But at least its interest cover is not so bad. Overall, we think it's fair to say that Great Lakes Dredge & Dock has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. To that end, you should be aware of the 1 warning sign we've spotted with Great Lakes Dredge & Dock .
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
