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. As with many other companies Chart Industries, Inc. (NYSE:GTLS) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does Chart Industries Carry?
You can click the graphic below for the historical numbers, but it shows that Chart Industries had US$558.3m of debt in March 2021, down from US$754.4m, one year before. However, it also had US$114.9m in cash, and so its net debt is US$443.4m.
How Strong Is Chart Industries’ Balance Sheet?
The latest balance sheet data shows that Chart Industries had liabilities of US$660.3m due within a year, and liabilities of US$426.0m falling due after that. On the other hand, it had cash of US$114.9m and US$261.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$710.4m.
Given Chart Industries has a market capitalization of US$5.36b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With a debt to EBITDA ratio of 2.1, Chart Industries uses debt artfully but responsibly. And the alluring interest cover (EBIT of 7.9 times interest expense) certainly does not do anything to dispel this impression. It is well worth noting that Chart Industries’s EBIT shot up like bamboo after rain, gaining 54% in the last twelve months. That’ll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chart Industries’s ability to maintain a healthy balance sheet going forward.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Chart Industries recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
The good news is that Chart Industries’s demonstrated ability to convert EBIT to free cash flow 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! Zooming out, Chart Industries seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. We’d be very excited to see if Chart Industries insiders have been snapping up shares.