Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Franklin Covey Co. (NYSE:FC) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 step when considering a company’s debt levels is to consider its cash and debt together.
View our latest analysis for Franklin Covey
What Is Franklin Covey’s Debt?
As you can see below, Franklin Covey had US$12.2m of debt at May 2019, down from US$51.8m a year prior. However, it also had US$10.9m in cash, and so its net debt is US$1.39m.
How Strong Is Franklin Covey’s Balance Sheet?
We can see from the most recent balance sheet that Franklin Covey had liabilities of US$82.4m falling due within a year, and liabilities of US$31.3m due beyond that. Offsetting this, it had US$10.9m in cash and US$53.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$49.9m.
Since publicly traded Franklin Covey shares are worth a total of US$536.1m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, Franklin Covey has a very light debt load indeed.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Franklin Covey has a net debt to EBITDA ratio of 0.097, suggesting a very conservative balance sheet. But EBIT was only 1.2 times the interest expense last year, which shows that the debt has negatively impacted the business, by constraining its options (and restricting its free cash flow). Notably, Franklin Covey made a loss at the EBIT level, last year, but improved that to positive EBIT of US$2.9m in the last twelve months. 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 Franklin Covey 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 it’s worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Franklin Covey actually produced more free cash flow than EBIT over the last year. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
Happily, Franklin Covey’s impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its interest cover has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Franklin Covey can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it’s worth keeping an eye on this one. Even though Franklin Covey lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending over the last few years.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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