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 note that C.H. Robinson Worldwide, Inc. (NASDAQ:CHRW) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.

How Much Debt Does C.H. Robinson Worldwide Carry?

The image below, which you can click on for greater detail, shows that at June 2021 C.H. Robinson Worldwide had debt of US$1.37b, up from US$1.09b in one year. However, because it has a cash reserve of US$172.8m, its net debt is less, at about US$1.19b.

How Healthy Is C.H. Robinson Worldwide’s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that C.H. Robinson Worldwide had liabilities of US$2.59b due within 12 months and liabilities of US$1.41b due beyond that. On the other hand, it had cash of US$172.8m and US$3.46b worth of receivables due within a year. So it has liabilities totalling US$368.1m more than its cash and near-term receivables, combined.

Of course, C.H. Robinson Worldwide has a titanic market capitalization of US$11.7b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

C.H. Robinson Worldwide’s net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 36.7 times the size. So we’re pretty relaxed about its super-conservative use of debt. On top of that, C.H. Robinson Worldwide grew its EBIT by 35% over the last twelve months, and that growth will make it easier to handle its debt. 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 C.H. Robinson Worldwide can strengthen its balance sheet over time.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, C.H. Robinson Worldwide produced sturdy free cash flow equating to 70% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that C.H. Robinson Worldwide’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don’t think C.H. Robinson Worldwide is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. 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.