Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ 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. We can see that Landstar System, Inc. (NASDAQ:LSTR) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Landstar System Carry?
As you can see below, at the end of June 2021, Landstar System had US$70.6m of debt, up from US$35.5m a year ago. Click the image for more detail. But on the other hand it also has US$239.0m in cash, leading to a US$168.4m net cash position.
A Look At Landstar System’s Liabilities
Zooming in on the latest balance sheet data, we can see that Landstar System had liabilities of US$720.2m due within 12 months and liabilities of US$152.8m due beyond that. Offsetting this, it had US$239.0m in cash and US$952.8m in receivables that were due within 12 months. So it actually has US$318.7m more liquid assets than total liabilities.
This surplus suggests that Landstar System has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Landstar System has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we’re happy to report that Landstar System has boosted its EBIT by 58%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Landstar System can strengthen its balance sheet over time.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Landstar System has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Landstar System recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
While it is always sensible to investigate a company’s debt, in this case Landstar System has US$168.4m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 58% over the last year. So is Landstar System’s debt a risk? It doesn’t seem so to us. When analysing debt levels, the balance sheet is the obvious place to start.