Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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. Importantly, Tecnoglass Inc. (NYSE:TGLS) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Tecnoglass’s Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Tecnoglass had debt of US$180.8m, up from US$168.5m in one year. However, it also had US$131.2m in cash, and so its net debt is US$49.6m.
How Healthy Is Tecnoglass’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Tecnoglass had liabilities of US$239.0m due within 12 months and liabilities of US$180.6m due beyond that. Offsetting these obligations, it had cash of US$131.2m as well as receivables valued at US$192.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$96.2m.
Of course, Tecnoglass has a market capitalization of US$1.68b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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.
Tecnoglass’s net debt is only 0.16 times its EBITDA. And its EBIT easily covers its interest expense, being 30.5 times the size. So we’re pretty relaxed about its super-conservative use of debt. On top of that, Tecnoglass grew its EBIT by 61% 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 Tecnoglass can strengthen its balance sheet over time.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Tecnoglass recorded free cash flow of 32% of its EBIT, which is weaker than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
The good news is that Tecnoglass’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Zooming out, Tecnoglass seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. The balance sheet is clearly the area to focus on when you are analysing debt.